Specialist financial planning practice

Should investors take action before the election?

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29 April 2015

Should investors take action before the election?

FT.com had a headline last week that read: “Goldman warns of sell-off if Labour win”. Of course, investment banks make money from trading and therefore have an incentive to drum up activity; but some of our clients and friends have also expressed concern about how the markets are likely to react if the coming election results in a Labour-led government. Our view is that it is far from obvious that British markets would fall if that was to happen. As always, the right approach is to stay calm, stay invested and stick to the long-term plan.

In the election of 1945, the Labour party defeated Winston Churchill’s Conservatives and gained its first ever majority in the House of Commons. The Conservatives had been widely expected to win, and the victory of a party committed to the nationalisation of major industries was a serious shock to the City. The Financial Times, with remarkable lack of perspective, called it ‘the most serious reverse since the dark days of 1940’[1]. The market, however, was not nearly so disturbed. The FT Industrial Index did fall 3.7% in the immediate aftermath of the election, but recovered within three months and thereafter quickly rose to a new high[2].

Why did the capital markets, which to many are intimately bound up with the very idea of capitalism, react with such calm to the election of a radical socialist government? The answer can only be because, as far as investors were concerned, the election of the new government did not make a large difference to the expected future cash flows from financial assets. The economy continued to function and companies continued to make profits and pay dividends (and the private shareholders of nationalised companies received market-based compensation[3]). For the markets, it is profits and dividends that count.

This observation translates to the situation we face today. According to research by the Capital Group[4] , 77% of the earnings of the FTSE 100 are derived from overseas and as such are unlikely to be much affected by the behaviour of the British government. But even if that were not the case, the reality is that government action has far less impact on our economy than do global economic conditions. The chart shows the annual rate of GDP growth in the UK and also the growth rate of GDP in the United States (to represent global economic conditions). The two move relatively closely together.

Annual Real GDP Growth (%), 1960-2014[5]

Post graph.jpg

To be clear, we do not have a view on whether the UK markets will rise or fall, whichever party leads the next government. The point is that, even if a government that is relatively left-leaning compared to those of recent decades was to come to power, it is far from obvious that that would have a deleterious effect on either the UK economy or on stock-market valuations. A fortiori, it is far from obvious that the ideology of the government will be the most important determinant of asset prices in the coming months and years, such that it would be reasonable to sell out of equity markets on that basis alone.

Our view of the current market situation is exactly the same view that we always have. We do not know what is going to happen in the future. What we do know is that financial markets have provided investors with reasonable returns, on average, over the long run; and we know that our clients’ portfolios are already set up with appropriate levels of risk, such that they should be able to ride out any periods of market turbulence. With that work done, the right approach is to stay calm, stay invested and stick to the long-term plan.

John Butters CFA, Chartered MCSI

Head of Investment

                                                 

[1] A History of the London Stock Market, 1945-2009, GG Blakey, Harriman House 2011

[2] Ibid

[3] Crisis in Britain: Plans and Achievements of the Labour Government, RA Brady, University of California Press 1950

[4] Quoted on CityWire.co.uk, 12 November 2013

[5] Sources: Federal Reserve Bank of St Louis, OECD, Bureau of Economic Analysis