Updated: May 19, 2022
The world has known the date of the UK's general election for the last five years and, while it may cause some short-term volatility in the equity, gilt, and currency markets, will this be significant enough for people to need to take defensive positions?
"Less progressive taxes mean more money flows to people who do not need it"
I suspect the temptation for market strategists, given how difficult it is to have any sort of edge with respect to predicting the election outcome – let alone understand what the implications are of each – is to say something along the lines of it being likely to create volatility in the short term, but have little bearing on things over the longer term.
And yet, intuitively, it feels like it should matter and therefore there must be important implications for investors. Which theory is correct?
Approaching this question theoretically, a Labour or Labour-led government should be worse for the equity market and for sterling than a Conservative or Conservative-led government. Under Labour, taxes are likely to more progressive than under the Conservatives, and while it may seem odd, this would, at the margin, be less positive for markets.
Harsh as it may sound, higher taxes on lower income groups, relative to what would be the case under Labour, would be good for financial markets. Because less progressive taxes that are the norm under Conservatives mean more money flows to people who do not need it – the rich – who then put it in the stock market.
And, once the rich get richer, according to Oxfam head of research Ricardo Fuentes-Nieva, they "get more resources to influence even more on how the tax code is modified, and thus lock the gains and protect the trend that mostly benefits them".
Of course, squeeze lower income groups too much and you get social instability that would be negative for financial markets. But I suspect we are some way away from that. True, much of the wealth created in recent times, real or apparent, has accrued to high income groups, but it is not as if real disposable income for lower income groups has fallen (since 1995, the average final income per household for the lowest quintile has risen by 141% compared with a rise in the retail price index of 71%).
And, remember, we have come a long way since 1974, the year in which Dennis Healey, at least allegedly, announced that Labour would "tax the rich till their pips squeak". All parties now understand the need to incentivise the more able to put their skills to good use in order to help make life better for the rest of us. So, even under Labour, the UK would still be a great place to live, strive and prosper, if perhaps slightly less so than under a Conservative government.
Indeed, the two main parties nowadays are so much closer together than they used to be that it is hard to discern a difference (this may go a long way to explaining the apathy among investors currently). Even the differences, where you do find them, may be more apparent than real. Opposition parties need to take a contrary stance to the incumbent in order to get elected but once and if elected, often change their tune.
Approaching the question empirically gives a different view.
At first glance, history would suggest investors should be hoping for a Conservative or Conservative-led government. There have been 13 governments since 1964, seven of them Labour and six Conservative (or Conservative-led). The average annualised performance of the FTSE All Share under Labour was -3.9%, while under the Conservatives it was +11.1% (let us accept for the moment that thirteen is a big enough sample size).
The difference of 15 percentage points is substantial, but is it possible the Conservatives were in power during periods in which stock markets globally were stronger? Using the US as a proxy for global markets, under Labour the All Share underperformed by 3.4%, and under the Conservatives by 0.4%. This suggests the Conservatives were indeed lucky but that they were still better than Labour for the equity market.
However, the 1974 Labour government was particularly unlucky in that the first oil shock, hardly its fault, fell under its tenure. Excluding this, the All Share outperformed by 3.2% per annum under Labour and, as mentioned, underperformed by 0.4% under the Conservatives. So the situation is definitely not as clear cut as it first seemed.
Exchange rates were fixed for the first three periods in our sample, but for the other ten, under Labour, sterling fell by an annualised 0.2% relative the US dollar and under the Conservatives by 1.1%. Again, Labour comes out on top. I could go further and look at the real effective rate of sterling but there is no point. Why? Because a sample size of ten means the results are meaningless. Even 13 is too small. The point, if there is one, is there is no evidence whatsoever that the stock market and currency fare better under one party than the other.
This is the reality for investors who, rather than worry about the election, should instead worry about important economic issues such as the massive current account deficit or the vulnerability to another shock of the UK's financial services sector.
Published in Investment Week
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.