How will markets react to the upcoming general election?
As has been the case in all recent votes, the pound remains the main barometer of sentiment. The more uncertain the outlook for Brexit negotiations, the further it falls, thanks to the fact that the UK continues to run a large current account deficit, and funding it becomes more difficult against a background of uncertainty. However, the asymmetric downside risk to sterling that we identified (and insured against) ahead of last year’s referendum is nothing like as extreme this time because the pound has already fallen a long way and is generally considered to be better value.
Large capitalisation equities will continue to follow global trends owing to their heavy overseas earnings exposure, with a weaker pound providing something of a boost. Mid and small-cap equities with more domestic exposure would fare less well under a weaker pound, reversing some of the recovery they have made as the pound rallied and the economy surpassed most expectations.
Gilts also tend to follow global trends, but, as we saw last summer, can benefit from their safe haven status in uncertain times. However, we suspect that they would not react so well to “tax and spend” Labour plans, even though Labour offers a “softer” Brexit. Also, with a yield of just over 1%, the conventional UK 10-year gilt continues to offer little return. We have a marginal preference for index-linked Gilts which offer protection against inflation caused by a weak pound.
Putting all this together, we find it difficult to make a case for specific evasive action ahead of Thursday, especially as the betting markets still find a decent Conservative majority to be the most probable result. If not, our existing exposure to non-UK assets will provide a decent cushion.
John Wyn-Evans, head of Investment Strategy at Investec Wealth & Investment