How to prepare portfolios for the ballot box

Prime Minister Theresa May’s decision to call a snap General Election on 8 June is creating waves in the financial markets and provoking a deluge of comment (to which this column must accept it is regrettably contributing).

The initial market response saw stocks fall, Gilts hold their ground and sterling rally, before a more measured view saw small- and mid-cap stocks start to recoup lost ground and in the process outperform the large-caps. In addition, domestically-focused equity sectors like retail and real estate started to outperform miners, oils and exporters.

This in effect reverses the trends witnessed since the EU referendum vote last June, whereby multinational large caps have beaten more UK-centric mid- and small-caps, helped by the weaker pound and its effect of boosting the value of overseas earnings and assets.

While it will be tempting for advisers and clients to try and second-guess the election result and its implications for portfolios this column would politely suggest such a temptation is best resisted for three reasons.

  1. The Brexit and US Presidential polls are just recent reminders of the perils associated with judging the effect of politics on securities prices. Both the final outcomes were expected to be negative for equity markets in particular, yet the decision to leave and Trump’s win led to galloping gains in the FTSE 100 and S&P 500. As Bertrand Russell once put it: “Even if all the experts agree, they may well be mistaken.”
  2. Sterling’s sudden rally toward the $1.28 to $1.29 range, compared to its post-Brexit lows of barely $1.20, is being attributed to hopes that a larger Conservative majority will enable Theresa May to tear up much of the existing party manifesto, dumping the straitjacket of austerity and going for more pro-growth policies. This sounds like the Trump/reflation trade reincarnated and wrapped in a Union Jack (rather than the Stars and Stripes) – and that market trend looks to be running out of puff rather badly after just three months of the Trump administration. In addition, trading currencies is a mug’s game so basing an investment strategy on forex movements should surely be treated with caution.
  3. In the end, total returns from securities and the funds that hold them are dictated by profits and more particularly cash flow. Government policy can affect these, at least in the short term, but in the long run cash flow results from a company's competitive position, its pricing power, financial strength and management acumen. Events in 10 Downing Street may have little or no impact upon any of these four vital facets of corporate achievement and as such the result released on 9 June must be kept in perspective, especially by those advisers and clients who run their portfolios on a long-term time horizon.

In sum, this column tends to agree with US investor Warren Buffet (as it does, for better or worse, on so many other issues), who once pithily noted: “If you mix your politics with your investment decisions you are making a big mistake.”

Stock markets

Advisers and clients may nevertheless like to stress-test their asset allocation, to ensure they are running balanced portfolios designed to weather a range of possible economic and political scenarios and not just one. (Horrible to admit as it is, none of us has a crystal ball and we are therefore all capable of being wrong, so preparing for such an outcome is just a practical precaution).

As such this column has studied every General Election results to see if there are any (short-term) lessons which can be drawn for equities, Gilts and sterling.

For stocks, three possible conclusions become apparent. Please note that the findings in this and all of the other examples below are based purely on historical data and in no way represent an endorsement of any particular party or political philosophy or indeed the views of either this particular column or AJ Bell as a whole.

  • Our analysis of General Election results since the inception of the FTSE All-Share in 1962 shows that the index has tended to do better, on average, under Conservative Prime Ministers. This may offer some comfort to advisers and clients who are nervous, especially as Mrs May has a big lead in the polls.

The UK stock market has historically done better on average under Conservative Prime Ministers

* 1964/66 to 1970 and 1974/74 to 1979 counted as one term
Source: Thomson Reuters Datastream.

  • The mid-term elections of 1966 and 1974 failed to derail stocks. In these cases, however, the UK stock market seemed unconcerned by either the party affiliation of the person in charge or the size of their majority. Nor does there appear to be a correlation between stock market performance and a Government’s majority – so while Mrs May will want to add to her party’s haul of seats in Westminster this may be less of a concern for advisers and clients, relative to the overall result.

The UK stock market does not appear to be moved by the size of a Government’s majority

* Initially won majority of 4 in 1964. Increased to 96 in 1966.
* Initially a minority of 33 in February 1974. Won majority of 3 in October 1974.
Source: Thomson Reuters Datastream

Gilts

Our data for the UK Gilt market does not quite go as far back as for equities, though it still covers eight elections and five PMs. To run through the same two questions as for stocks:

  • The Gilt market seems to prefer a Conservative Prime Minister.

The UK Gilt market has historically done better on average under Conservative Prime Ministers

* 1964/66 to 1970 and 1974/74 to 1979 counted as one term
Source: Thomson Reuters Datastream.

  • The size of a Government’s majority appears to be of no interest at all to holders of Gilts.

The UK Gilt market does not appear to be moved by the size of a Government’s majority

* Initially won majority of 4 in 1964. Increased to 96 in 1966.
* Initially a minority of 33 in February 1974. Won majority of 3 in October 1974.
Source: Thomson Reuters Datastream

Sterling.

Here our data goes all the way back to Harold Wilson’s win for Labour over the Tories’ Alec Douglas-Home in 1964, to cover 14 ballots and eight leaders. Again, in order, using sterling-dollar as a reference point:

  • Here the market appears to have little or no political preference.

The currency markets have historically been agnostic as to which party provided the Prime Minister

* 1964/66 to 1970 and 1974/74 to 1979 counted as one term
Source: Thomson Reuters Datastream.

  • The currency markets are unconcerned by the size of the ruling party’s Westminster majority.

The currency markets have historically been unmoved by the size of a Government’s majority

* Initially won majority of 4 in 1964. Increased to 96 in 1966.
* Initially a minority of 33 in February 1974. Won majority of 3 in October 1974.
Source: Thomson Reuters Datastream

Conclusion

As we all know, the past is no guarantee for the future. Moreover, opinion pollsters have not covered themselves in glory of late. As such advisers and clients are unlikely to take too much on trust, given that policy on such huge issues as Brexit and Scottish independence, as well as the state of the nation’s finances and economy, are set to be a source of fierce debate once more.

Yet unless they think the election result due in the early hours of 9 June will lead to the implementation of policies that could directly and materially affect a substantial portion of portfolio’s asset allocation, or the holdings of a key fund, then they may be better off doing as little as possible, despite the political uncertainty.

At least that means they won’t incur the near-term commissions or the frictional costs which can come with trading and which will definitely erode their total returns over the long term.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.

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