Following Labour’s previous landslide victory in 1997, the FTSE 100 rallied by a whopping 25 per cent; investors hoping for a repeat of this past success should be aware that while stable politics can be somewhat supportive for UK assets, it is not the only factor determining their performance.
Labour’s recent landslide victory has prompted questions about the investment implications for advisers and their clients. One such question is whether Labour can help usher in a new honeymoon phase for hitherto unloved UK stocks, bonds and the currency.
UK stocks have struggled to replicate the gains observed in the 1990s, when falling inflation and long-term bond yields provided a highly supportive environment.
At that time, prosperity and peace provided the foundations of multi-decade highs for price-to-earnings ratios. But in recent years, the backdrop for UK equities has deteriorated, and allocations to the asset class have dwindled.
Unlike the highly supportive context of the 1990s, a challenging Brexit process, the hard-hitting impact of pandemic, and high energy costs have all created a backdrop undermining the attractiveness of UK stocks.
Yet the residual effects of these factors today create a compelling investment opportunity, with UK equities trading at a discount on a sector-equivalent basis to the rest of the world.
There is support for a further UK equity rally
This attractiveness from a valuation perspective could be added to by the expected end of a prolonged period of high interest rates. The Bank of England kept rates steady at 5.25 per cent in June, but advisers and direct investors alike are watching closely for a potential cut in August.
Lower interest rates are generally supportive for share prices, so a downward shift by the BoE may lift UK equity markets.
Investors here and overseas have been apprehensive about UK equities for many years since the referendum vote, leading to low exposures. This too provides the potential for a more positive global view on the UK to elevate its performance vs other markets.
Turning to government policy, only a drastic change to corporate tax would be likely to alter the direction of stocks.
Gilts meanwhile are sensitive to both inflation risks and blowout spending, but so far, Labour looks to be adhering to its fiscal straitjacket. This creates an environment that is stable for stocks and supportive for gilts, particularly when compared to potentially bigger political shifts in Europe and the US.
The outlook for sterling is similarly somewhat detached from national politics, though this is now viewed as less of a negative. Currency is ultimately a relative game, so fluctuations in the US dollar matter more than a change of government.
In the longer term, government policies in support of foreign direct investment and portfolio flows may have a positive impact. The strength of the dollar owes much to huge incentives for foreign capital to invest in the US, as well as high fiscal spending.
