Why profits and cash flow matter more to stocks than new Prime Ministers
At the time of writing, the FTSE All-Share index is trading around the 4,000 mark. To accentuate the positives, this is just 8% below its May 2018 all-time high and more than a fifth higher than its post-Brexit-vote lows of summer 2016.
If you prefer a glass half-empty view, benchmark is no higher now than it was in March 2017, more than two years ago, and it looks to be going nowhere fast. President Trump’s trade war with China, concerns over global growth and the UK’s uncertain political outlook, in view of Brexit and the apparent collapse of the centre, can all be said to be having a negative impact.
The UK stock market has paddled sideways for more than two years
Source: Refinitiv data
It will be intriguing to see if markets latch on to the appointment of a new Conservative party leader, and thus Prime Minister, as a potential catalyst for performance. The governing party’s clear hope is that a new leader can break the Brexit impasse, provide certainty on what Brexit does – or does not – mean and stave off the prospect of an early General Election, before its scheduled date of 2022.
This may, however, be looking at the situation through rose-tinted spectacles. Whoever becomes PM, they will be the third consecutive incumbent in 10 Downing Street to hold the land’s highest office without winning a clear majority in a General Election (David Cameron coalitions after the 2010 and 2015 elections, as did Theresa May after 2017’s ballot). This is hardly a robust endorsement.
Moreover, history suggests it takes more than a new incumbent in 10 Downing Street to really get the stock market going.
“History suggests it takes more than a new incumbent in 10 Downing Street to really get the stock market going.”
Short, not sweet
It is unlikely that Theresa May enjoyed her time in office, as her entire tenure was spent wrestling with Brexit rather than outlining any major philosophy or legislative programme. If she can take any comfort at all, it is that she looks set to survive for pretty much three years in office by the time the new leader is appointed so she is not the shortest-serving PM of modern times (as defined by PMs elected since the Second Great Reform Act of 1867). That said, she may rather fancy taking Andrew Bonar Law’s mantle of being ‘the forgotten Prime Minister’, though her Brexit travails are likely to prevent that.
The ten shortest-serving UK Prime Ministers since 1867
Source: History Today, www.gov.uk, BBC
More importantly for advisers and clients, three Prime Ministers have taken office mid-way during a Parliament, following the departure of their predecessor, since the inception of the FTSE All-Share in 1964: James Callaghan and Gordon Brown for Labour, in 1976 and 2007, and John Major for the Conservatives in 1990.
“Three Prime Ministers have taken office mid-way during a Parliament, following the departure of their predecessor, since the inception of the FTSE All-Share in 1964.”
The arrival of a new PM mid-term has not tended to galvanise the UK stock market
Source: Refinitiv data
On average, the FTSE All-Share made no progress at all under the trio during their first 12 months in the hot-seat, rising 2.4% over the first three months of the new PM’s tenure, falling 1.5% over six months and coming in flat over a year.
We must accept that the past is no guarantee for the future, and must also acknowledge that this is a wide range of performances under new PMs that may well be a reflection of the different circumstances under which they came to power – stagflation under Callaghan, recession under Major and a galloping boom that was about to crash under Brown.
This makes it clear that while politics can be one near-term factor, there are many other issues at work when it comes to how the stock market performs.
The economy is one factor, but ultimately it is corporate profits and cash flows – and the price (or valuation) that advisers and clients are prepared to pay to access them – that really dictate how the FTSE All-Share will perform over the long term.
“Ultimately it is corporate profits and cash flows – and the price (or valuation) that advisers and clients are prepared to pay to access them – that really dictate how the FTSE All-Share will perform over the long term.”
With a dividend yield of around 4.5%, the FTSE All-Share can be seen as a 22.5-year duration bond (as this is how long it would take advisers and clients to get their money back, assuming no change in dividends or share prices).
This is a reminder of exactly why shares should be treated as a (very) long-term investment and why the role of short-term politics should not be over-emphasised, as very few Prime Ministers have lasted for much more than one full term of office, at least since the inception of the FTSE All-Share in 1964.
Fresh convulsions in Westminster and Brussels could therefore be an opportunity to reassess the case for UK equities, especially if the pound or FTSE All-Share come under pressure and valuations become more attractive. After all, the arrival of a new PM, coupled with the European Parliamentary election results, may lead to further delays in the Brexit negotiating process and even increase the prospect of the ‘no-deal’ scenario, whereby the UK leaves the EU under World Trade Organisation terms, from which the equity market has run scared ever since the referendum result in June 2016.