Monday, 1 February 2010

Stocks Won't Rise On A Change of Government...

I my Money Week column this week, I've been looking at why stocks won't rise on a change of government. Here's a taster....

The date of the next British election may still not have been decided. Still, one thing is certain. A date has to be set for early June at the latest, with May 6th 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, and trying to keep a straight face as Nick Clegg earnestly outlines his plans for government.
Amusement, and no doubt boredom aside, that will pose and interesting question for investors and the markets. If you look at the historical record, it suggests that this is the time to be backing Britain. Sterling traditional does well when the party in power is about to change. And, if you believe that, as the polls suggest, the Conservatives will be forming the next government, that too is a reason to buy: stocks have always done better under Tory administrations than Labour ones.
Not this time, however. In reality, investors should steer clear of the UK until well after the election is over. There is still too much uncertainty over the result. And it isn’t clear the country is ready for the kind of tough medicine it will take to get the economy back on track. Britain will be a buy again one day, but probably not until 2012 at the earliest.
So what does the past tell us is likely to happen this year?
In the past, you’d have made money by buying into British assets ahead of a change of government.
Take a look at 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 a 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 during 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 a 100 by the time Blair was getting used to the view from Downing Street. The markets were re-assured by all that talk from Gordon Brown about ‘prudence’ and ‘golden rules’. They turned out to be deluded, but no one knew that then.
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, of course, wasn’t invented back then). By the end of 1981 it had risen to 313. Pretty good.
It smiled on Blair as well. The FTSE was just over 5,000 when 1996 ended, and as 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 6930 in December 1999. What happened next wasn’t so good, but there is little question the change of government was good for stocks.
If a change of government is good for stock, 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, they dropped 7.5% under Clement Atlee, 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 UK stocks. Maybe it’s time to ditch those euros, and get rid of the Shanghai tracker, and get your money into the FTSE instead?
Well, not quite. True, the four most dangerous words in investment are ‘it’s different this time’. The past doesn’t always repeat itself, but it follows patters more often than we usually think. Those caveats accepted, however, it does actually look different this time around.
Here’s why.
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.
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 the UK is Greece minus the sunshine. The pound will collapse, and the equity markets with it, amid fears of insolvency.
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 swinging cuts to public spending, slashing wages in the public sector, whilst 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, with the Labour opposition will be braying that you can just print money instead. Don’t count on it winning that showdown.
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. Not very well, since you ask. Shares 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 it is clear the new government can get on top of Britain’s deficit. Unlike the past, you don’t want to be buying ahead of an election.

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