The date of the next British election may still not have been decided. Yet one thing is certain. A date has to be set for early June at the latest, with 6 May the most likely day. Within a couple of months, and possibly sooner, the country will be struggling to stay awake during Gordon Brown’s launch of his manifesto, while trying to keep a straight face as Nick Clegg earnestly outlines his plans for government.
A looming election poses an interesting question for investors and the markets. The historical record suggests that this is the time to be backing Britain. Not this time, however. Investors should steer clear of the UK until well after the election is over. Here’s why.
In the past, you’d have made money by buying into British assets ahead of a change of government. Take sterling: in the run-up to and the immediate aftermath of the two last changes of government, the pound rallied significantly. After falling to a level of 95 on a trade-weighted index in 1976, the pound soared to 130 by 1981. The tight budget restrictions imposed by the IMF, followed by the spending cuts of the incoming Thatcher government, restored the faith of the markets in the pound.
Something similar happened when Tony Blair took office. After falling steadily through the early 1990s, the pound climbed again in the second half of the decade. It dipped down to 80 on a trade-weighted basis in 1996, but was back above 100 by the time Blair was getting used to the view from Downing Street. The markets were reassured by all that talk from Brown about ‘prudence’ and ‘golden rules’. They turned out to be deluded, but no one knew that then.
So how about equities? Again, the record is encouraging. At the end of 1978, as the country went into an election year, the FTSE All-Share Index stood at 220 (the FTSE 100 hadn’t been invented back then). By the end of 1981 it had risen to 313. Pretty good. It smiled on Blair too. The FTSE was just over 5,000 when 1996 ended, and the country looked forward to the end of 18 years of Conservative rule. Over the next three years, it carried on rising steeply, hitting its all-time high of 6,930 in December 1999. What happened next wasn’t so good, but there is little question that the change of government was good for stocks.
And if a change of government is good for shares, changing to a Tory one should be doubly good. As John Littlewood pointed out in a recent report for the Centre for Policy Studies, shares always do far better under Conservative governments than Labour ones. The market rose by 74% under the 1951-1964 administration and by 166% under the 1979-1997 government. By contrast, it dropped 7.5% under Clement Attlee, 13% under Harold Wilson in the 1960s, 11% under the Labour government of the 1970s and, up until 2009, had dropped 26% under Blair and Brown.
The past, then, suggests that a victory for the Conservative Party in either May or June would be good for both the pound and British stocks. So maybe it’s time to ditch those euros, get rid of your Shanghai tracker and pile your money into the FTSE instead?
Well, no. True, the four most dangerous words in investment are ‘it’s different this time’. The past doesn’t always repeat itself, but it follows patterns more often than we usually think. Those caveats accepted, however, things do actually look different this time around. First, the result is by no means a foregone conclusion. The Conservative Party needs to win a huge number of seats to get a stable majority. Any sign of a hung parliament and the markets are going to wobble dramatically. And right now, the only thing keeping sterling alive is the prospect of a change of government. No one has any confidence in the willingness of Brown to bring public spending under control. If the election isn’t decisive, the markets will realise that Britain is Greece minus the sunshine. The pound will collapse, and the equity markets with it.
Next, it is by no means clear that a new Conservative government will have the clear mandate to deliver the tough medicine the economy needs. The Irish government has delivered swingeing cuts to public spending, slashing wages in the public sector, while keeping taxes down. There is very little sign that the public is ready for that in Britain, or that the unions will allow it. A Cameron government, with a slim majority, may face a tough battle with the public sector, while the Labour opposition will be braying that you can just print money instead. Don’t count on it winning that showdown. Indeed, Cameron might well be another Edward Heath: a prime minister who knows that tough decisions have to be taken, but doesn’t have the public backing to push them through. And how did stocks do under Heath? They fell 11% between 1970 and 1974.
Britain will be a buy again one day. The labour market is a lot more flexible than it was in the 1960s and 1970s. It may well bounce back relatively quickly. But it is not likely to happen until we know that the new government can get on top of Britain’s deficit. So forget the past – you don’t want to be buying Britain ahead of this election.