Understanding The Market Reaction Post-Election

Summary

  • Hung parliament.
  • Pound down.
  • Markets rewound after pricing in majority conservative government.
  • FTSE up.
  • Weaker pound increases overseas earnings, hung parliament reduces political risk.
  • Soft Brexit? Possibly, but a hard Brexit does have benefits.

On Thursday June 8th 2017 the British populace took to the polling stations to vote for their next parliament. In the UK a government is formed by voting in members of parliament (MPs), each tasked with running the politics of a particular constituency. In the UK there are 650 constituencies, and thus 650 seats up for grabs.

This election was expected to be a landslide victory for the incumbent conservatives, who in 2015 achieved a majority of 15. However Theresa May landed 9 MPs short, with 317 seats. A disastrous result considering the expectation of an increased majority.

The resulting hung parliament means that no single party has enough overall seats to ensure legislation can pass freely, and deals will need to be made between them – in this case by the conservatives and DUP (democratic unionist party of Northern Ireland).

Market reaction

GBP/USD £/$ poll shortly after 10pm on Thursday

At 10pm in the UK the polls closed and counting began. The post-voting poll showed a conservative minority government. The FTSE was closed at the time, so our initial market reaction came from the currency markets, where the pound fell 2% against the USD.

Why did the pound fall?

With pre-election polls throughout the month of May showing, in some cases, a 50+ seat majority for the conservatives the markets hadn’t priced in a minority government. In the build-up to the election  the pound had drifted upwards from mid $1.20s to $1.30.

This is because:

  • The market believed a larger majority conservative government going into the Brexit negotiations would offer greater certainty and direction.
  • The conservatives are also traditionally pro-business, which may suggest stronger economic growth.

Once the scenario of a majority conservative government began to become de-railed by the actual results, the markets adjusted their expectations of economic growth and the pound fell to a level more fitting for a hung parliament.

The stock market rose

This may seem counterintuitive, but the FTSE100 (the largest 100 companies in the UK) rose 1.4% following the result. This is shown in the graph below with a sharp rise on the 9th of June.

FTSE100 stock market

You may have expected, with a lack of a majority government and therefore the uncertainty of the future of British politics, that the stock market would have fallen. However in this case two things occurred:

  1. The weaker pound means that overseas earnings are now worth more ($1mn on Thursday at $1.30 =£769,230, $1mn on Friday at $1.27 = £787,401, a gain of +£18,171), which is reported on the company accounts as an increase in the profits of the company, and subsequently could lead to a higher dividend being paid. This pushes up the share price of the company.
  2. A hung parliament is actually not a bad thing for the markets. Because no one party can pass legislation unhindered, the process of enacting new laws and policies slows down. For the markets this translates as reduced political risk. For market participants a hung parliament signals a somewhat certain outlook that things will remain roughly the same for the next five years. Remember markets love certainty and loath uncertainty, and tend to prefer the status quo.

What next?

The next market moving event is Brexit. Unfortunately a minority parliament means that the conservatives did not attain the Brexit mandate they were expecting (not too much of a surprise considering more time was spent by the public analysing a social care bill, than each party’s plan for Brexit). As a result we could see prolonged Brexit negotiations, with markets (especially the pound, a now traditional measure of Brexit progress) remaining volatile. However on the flip side, now that May’s government has to pander to the DUP (who border the EU through the Republic of Ireland), we may see a softer Brexit, which could involve remaining in the single market. If this is the case the markets could respond favourably (low/no EU tariffs, maintained supply networks, less time spent negotiating bilateral trade agreements).

For the long term investor this is a blip in the ocean. Politics comes and goes. Ultimately the UK still has some of the highest quality names in industry and some with strong growth potential. Whilst a soft Brexit may be positive for the markets, if anything a hard Brexit would encourage businesses to innovate and become more efficient allowing for, and contributing to, a stronger economy in the future.

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