Duncan Lawrie Online ▼

Posted on: 14 May 2015

The General Election result was a shock for polling companies, providing the Conservatives with an outright majority and the UK with a return to one-party rule. However, while politically significant, UK elections are far less important to UK equities than is commonly assumed.

Last year we changed our recommended asset allocation to be more defensive and have since reduced our UK exposure. When we make such changes, we are looking years ahead rather than months and the election result does not change our caution regarding UK equity market valuations and the vulnerability of sterling.

In fact, the US market is far more important to the performance of UK equities than our domestic politics. The chart below shows US and UK equities since 1984 and you can see that, while UK shares have underperformed in recent years, in terms of trend London follows Wall Street. We will be watching the US economy with interest and expect markets to be volatile in the run up to the first rate increase by the Federal Reserve.

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There is one political issue that will be a focus for markets now the election is out of the way. With a Conservative majority, the Government will press ahead with its plans to hold a referendum on our EU membership, perhaps as early as next year. While the prospect of a perceived anti-business Labour government was not popular in board rooms, the thought of the UK leaving the EU will be of equal or greater concern. This would have enormous economic consequences that will feature heavily in our asset allocation discussions in the months ahead.

Despite its post-election rally, we believe sterling faces medium- to long-term headwinds. The UK has the largest current account deficit in its history, which means we are very reliant on capital from overseas and vulnerable to economic shocks. This is one of the main risks to the economy highlighted by the Bank of England.

Another concern is the economy's low level of productivity, which suggests that future economic growth could be more muted than in the past. Other threats to sterling include the UK's potential departure from the EU and a breakup of the union with Scotland. Within this context, the dollar looks like a more robust currency.

The central thesis behind our conservative asset allocation positioning is that the equity bull market that began in March 2009 is now at a mid to late stage. Corporate profit margins are also high and the next move in interest rates is likely to be higher. While markets can and may make further upward progress, returns will be lower than in the last few years and vulnerable to setbacks. The UK General Election was an interesting event, but does not change these facts. Therefore, although we will follow Government policy closely, particularly plans for an EU referendum, nothing we have seen so far changes our thinking.
 

To read more news from The Commentary May 2015 edition please click here


All data has been compiled by Duncan Lawrie from sources believed to be reliable. Full details of sources are available on request.

The comments and figures in this document are generally applicable but you should always take specific advice to suit your individual circumstances before taking any action. Errors and omissions excepted.

The value of investments and income generated may fall as well as rise, and investors may not get back the  amount invested. Past performance is not a reliable indicator of future results.