The UK election result – a hung parliament with no party winning an outright majority – is an outcome that will create uncertainty in the short term within the UK for both the Conservative leadership and, more importantly, for those charged with the ‘Brexit’ negotiations. We believe, however, that whilst the risk premium for UK assets has risen as a consequence of this result, there are other worldwide factors which mean that investment opportunities exist for investors at this time.
It is true that investment markets would have preferred a comfortable Conservative majority; however, there is also a school of thought that a hung parliament may lead to a softer outcome in the upcoming ‘Brexit’ talks with our European partners. Global markets continue to perform well and therefore, although negotiations with the European Union will be more complicated following this election result, our view is that the UK will simply become of less relevance to international investors.
The long-term outlook for the UK economy will, of course, be affected by the negotiations with Brussels. In the near term, however, it is the fortunes of sterling that are most likely to influence the UK stock market. Currency movements will inevitably have a significant bearing on the relative performance of the FTSE 100 and FTSE 250 indices. UK economic data has weakened, as indicated by rising inflation and 10-year Gilt yields. Both have acted as headwinds to more domestically-oriented small and mid-cap market, although these companies continue to trade at cheaper valuations than their larger peers.
As far as UK interest rates are concerned our view is that, in the current environment, the Bank of England is unlikely to raise them for the foreseeable future. We should also bear in mind that there is also no likelihood of an emergency rate cut of the sort we saw following the ‘Brexit’ result last June.
One market positive from the election is the reduced risk of another Scottish independence referendum.
In global terms our view is that the overall economic recovery will continue and inflationary concerns will recede. The election of President Macron in France and the softening of President Trump’s stance on protectionism in the US have contributed to the belief that political risk seems to be moderating. We expect investors to return now to examining ‘macro’ issues such as global growth prospects, the impact of the unwinding of Quantitative Easing, longer term inflationary pressures and, of course, interest rates.
Current economic data suggests that the Eurozone, led by Spain Portugal and Germany in particular, shows signs of a sustained recovery, although the outcome of the Italian election due to take place in 2018 may have some impact. In the US, as confidence in the new political regime grows, we anticipate further corporate investment and continued consumer spending. The Japanese economy has performed above expectations during the early part of 2017; however, events there are being closely monitored to determine the sustainability of this progress. In developed Asia the picture is more mixed as there are some early indications that Chinese demand has weakened recently and that regional manufacturing indices are stalling.
Overall, the underlying economic scenario is supportive of risk assets but we remain in a world where there are significant structural and political risks which will be translated into portfolio volatility. We remain cautious in our positioning with the portfolios and continue to apply our principles of geographical and asset class diversification to maximise returns for our clients within appropriate risk boundaries.