Snap - political risks return - or do they?
21 April 2017
It appeared very opportunistic of Theresa May to call a snap election on June 8, after the latest polls showed the Tory party with the biggest lead ahead of Labour for probably 3 decades. Predictably, most of the media have focused on the short-term potential for the Conservatives to significantly increase their parliamentary majority. Much has also been commented on how a strengthened and specific mandate for May's government will vastly improve her negotiating position with the EU, as well as her own Eurosceptic firebrands, in the Brexit negotiations.
In our view, the more important consideration is how a parliamentary reset this year removes some time pressure points beyond 2019, which previously looked to make the Brexit negotiations very difficult indeed. Until the June 2017 elections were called, the next general elections were scheduled for 2020. This perspective of re-election pressures, just 1 year after the formal Brexit and most probably while many transition negotiations will still be ongoing, made it very difficult to see how both side could possibly reach mutually beneficial '˜divorce' terms. A 2022 election date introduces considerable stress relief.
Currency markets, which have, in my view, provided the least biased assessment whether certain Brexit related events may be good or bad for the UK's future, appeared to agree with our view. Â£-Sterling strengthened - even if it was not quite as dramatic a gain as some of the media interpreted it: Roughly 1% against the â‚¬-EUR and 3% against the currently weakening US$. UK stocks, which have been trading inversely to the movement of the UK currency since the referendum, reacted more than the currency movement would have suggested, but that was more likely caused by the general downtrend in equity markets of the past 3 weeks. We would disagree with those who now suggest that Sterling will strengthen considerably further in the near term. Under the current election outcome scenario, Brexit still means Brexit - even if the path to get there should now be a bit longer and potentially less bumpy.
In conclusion, at Tatton we are of the opinion that calling an election now was the right decision for Theresa May. From a democratic legitimisation standpoint, it strengthens her electoral mandate and, from a UK strategic angle, it dampens some of the time pressures the Brexit negotiations would have inevitably experienced. That is obviously only if the election outcome reflects the current polls - and how unreliable they are in predicting electoral outcomes we have just painfully experienced twice over the past 2 years (For more comment on the election please see the dedicated article further down).
For Britain, the snap election call dominated the week, but, globally, the first round of the French presidential election over the weekend and the Turkish referendum outcome from the previous weekend dominated. Turkey's president Erdogan achieved a slim majority for his constitutional reform that will shift power from parliament to him. Importantly, he won no majority in Istanbul and Ankara, which spells continued friction and trouble for a country that, under his divisive leadership, has already fallen from one of the fastest growing developing countries into enduring recession.
France's economic growth prospects, on the other hand, are currently surpassing even Germany's. At the time of writing, the election outcome is unknown, but there is a strong expectation that populist and '˜Frexit' supporter Marine Le Pen will not finish as the leading candidate for the second round, despite a high probability of her finishing second. As long as the other top 2 finisher is not left populist Melenchon (which seems unlikely), then we can reasonably expect Le Pen to lose the 2nd round, as the moderate majority would unite behind the remaining moderate candidate.
From this vantage point, politics may dominate the headlines, but the political risk scenario appears less uncertain than it was at the beginning of the year. If it pans out as I outlined then, it will be a relief for capital markets, which have recently lost momentum on the back of increasing indications that 2017 economic growth will just be a little (but not substantially) better than 2016.
That the slow but steady stock market downtrend of the past 3 weeks halted this week (UK being the exception), was not because of the above, but because of the first batch of Q1 corporate earnings announcements. As we discussed last week, in light of the lack of decisive direction from economic indicators, there is a larger than usual focus on corporate results and outlook statements. The first nearly 100 results managed to beat the already optimistic expectation we mentioned last week, and have thereby (for now) provided support for markets, which are nervous about valuation levels they attained when 2017 growth prospects were still higher - particularly in the US.
For the near-term, strong Q1 corporate results would help to stabilise the market, but the recently softer data from the US, the UK and some parts of the Chinese economy tells us to continue to be cautious and prepared for a potential market setback, should another growth scare emerge. Once again, falling yields in global bond markets tell a similar story, although they might be as well a bounce back from oversold bond markets at the end of last year, on the insight that the global economic expansion continues to progress only at a moderate speed.
To close on another positive note, this moderation in outlook has, to my mind, actually reduced overall investment risks for 2017. This is because the much discussed scenarios from the beginning of the year - economic overheating ending the cycle, financial stresses from surging interest rates and credit costs causing similar damage - have all but disappeared beyond the economic horizon.