A new dawn for markets as global elections continue

Shifts in political priorities will play out but don’t necessarily have big or long-lasting negative effects on markets. As the UK sets out with a new government, the omens are positive for market returns. Across the channel, there is more uncertainty. UK equity underperformance since the 2016 Brexit vote might continue to reverse.

Clear result: Markets up

A clear change in the political complexion of government and/or the achievement of a sizeable majority in parliament have tended to be the conditions necessary for a positive response from UK financial markets. The general election’s results satisfy both. As a result, I would expect UK equity markets to perform well and the gilt market to rally, based on both a lower political risk premium and the prospect of Bank of England interest rate cuts. The last time Labour took office after an extended period in opposition and achieved a sizeable majority of seats was in 1997. A month after the election, the FTSE 100 was 4% higher and gilt yields were 22 basis points (bp) lower. A year on and the FTSE 100 was up over 35% and gilt yields were 160bp lower.

Positive on balance

Of course, superior UK financial asset returns are not guaranteed but there are favourable tailwinds. The election removes from office a government tainted by the turmoil of Brexit and multiple leadership changes, as well as negative optics over behaviour. Politicians underestimate how that reflects on a country in the eyes of international investors. In addition, the UK equity market is cheap relative to its peers and so is the currency. As such, it is ripe for global buyers. On the macro front, we see growth rising from the 0.3% year-on-year rate registered in the first quarter to somewhere between 1.0% and 1.5% in 2025. There are upside risks to that, especially if monetary policy is eased. On the fiscal side, the outlook is not great but the UK is in no worse a position than many European peers and the US. There is no reason gilts should underperform other developed sovereign bonds.

Details

Labour’s manifesto was characteristically short on detail. It says it will prioritise growth and any budgetary ambitions will be fully funded. There are promises to reform the energy sector and improve infrastructure by extending state ownership of the railways, modernising ports and prioritising road building. There may have been some lessons learned from the US as well, given the focus on green energy as part of a broader industrial policy. All of these are geared towards “kick-starting growth” as the manifesto claims. A better relationship with Europe is promised, although this falls short of any kind of commitment to rejoin the Single Market or the Customs Union. 

Disruption

On the global scene, geopolitical risks impact markets through potential consequences for demand and supply channels. Events such as terrorist attacks (or the threat of them), heightened military tensions or outright conflict impact consumer and business spending in the regions affected. Movement of people (travel), goods and capital flows can be affected negatively. Market access for imports and exports will also suffer. Investments in firms engaged in activity directly or indirectly with countries and regions suffering geopolitical conflict will become riskier. As we saw in 2023, a geopolitical event can create a supply shock and lead to inflation, which in turn means higher interest rates and adverse growth and investment implications. If Russia had not invaded Ukraine, there would not have been such an energy price shock, rates might not have gone up as much, bond returns would have been less negative and growth in Europe might have been stronger. 

Macro impact

That geopolitical event did impact on spending and investment decisions as businesses and consumers became risk averse. The macro risk materialised. It was negative for growth and did lead to higher risk premiums (lower prices) in equity and credit. However, investors can take comfort in the fact that, often, markets overreact to geopolitical events. Initial responses create buying opportunities and the reach of disruption is often less than feared. As the old saying goes, there is nothing to fear but fear itself.

The biggest fear today is of a new global conflict between the West and an alliance of China, Russia, India, and others of the Global South. That is a tail risk that could impact on global capital allocation (deglobalisation) and adaptions to supply chains. Tensions exist and have become more tangible in recent years, and the potential re-election of Donald Trump in the US could intensify them. But here we are with equities at record highs and real bond yields stable to moving lower. In the short-term, trade the economics not the politics.

Round two

There will be time to assess what happens in the US later this year, depending on whether the Democrats do replace Biden or not. There is more talk of ‘Trump wins’ trades – which are a little bearish for Treasuries (fiscal expansion and inflation), bullish for the dollar and may lean a little against the technology bubble. But they are not impacting pricing right now. Indeed, the bond market is more focused on the timing of a Federal Reserve easing as the data flow weakens (July rate cut a potential surprise?), and equity markets remain fuelled by the concentrated artificial intelligence-driven frenzy. So far, volatility has remained quite low (the VIX is at 12), and everyone is pointing to July being, historically, a favourable month for bond and equity returns. The last semester of 2024 might not be so calm.

(Performance data/data sources: Refinitiv DataStream, Bloomberg, as of 4 July 2024, unless otherwise stated). Past performance should not be seen as a guide to future returns.