Stray Thoughts on the UK Election

The final tallies are in, the exit poll more or less held, and the UK now has a hung Parliament. Theresa May remains Prime Minister and is off to form a government with Northern Ireland's Democratic Unionist Party (DUP). May lost her Conservative Party's majority, but the Tories' 318 seats plus the DUP's 10 equals 328-2 more than needed to win a confidence vote. As of now, it isn't clear whether May will aim for a coalition with the DUP or secure their support for a minority government, but either way, it looks like the UK will get plenty of political gridlock-bullish for stocks, as we wrote yesterday. Here are some other interesting nuggets, including a few underappreciated positives for investors.

MayDay! MayDay!

Perhaps the biggest surprise is that Ms. May still has a job. Calling a snap election three years early to increase your majority-only to lose 13 seats and be forced into a coalition or minority government-is the textbook definition of a political screw-up. Bookies are already making odds on her replacement, with Boris Johnson the favorite.^[i] Labour leader Jeremy Corbyn, who has decided to ignore math and claim victory, has called on her to resign. Tory MPs and cabinet ministers are a bit cagier, and party bigwigs don't seem to want the chaos of leadership challenge, but it's clear her hand is weakened. Maybe not to the extent portrayed by the Evening Standard, where former Chancellor-turned-editor George Osborne-sacked by May last year-had perhaps a bit too much fun with cover layout overnight,^[ii] but it's hard to envision her accomplishing much now. Tory backbenchers have plenty of leverage over her. So do the DUP's 10 MPs. With Sinn Féin winning 7 seats and vowing to continue abstaining from Parliament, May needs just 322 votes to pass legislation, rather than 326, so she doesn't need every Tory and DUP MP to fall in line. But if all it takes is seven rebels to block a bill, that argues for a very inactive, squabbly Parliament. If you like riffing on campaign slogans, we invite you to call it a Strong and Stable Coalition of Chaos.

The Tories' manifesto raised a lot of hackles in the business and investing world, but we daresay investors needn't fear energy price caps, tax rises or the end of the pension "triple lock" passing anytime soon. Even though Labour likes energy price caps too, it's questionable whether they'll bless a bill they don't think goes nearly far enough. Comfort with the status quo usually spurs risk-taking and investment, which markets like.

So Much for IndyRef2

May wasn't the only party leader to have a terrible night. The Scottish National Party took a drubbing, losing 21 seats-including 12 to the Tories, 6 to Labour and 3 to the Liberal Democrats, embarrassing party leader (and Scotland's First Minister) Nicola Sturgeon. The Conservatives even unseated the SNP's parliamentary leader, Angus Robertson, and former SNP leader Alex Salmond. Scots largely blamed the SNP's bad night on Sturgeon's push to hold a second independence referendum, otherwise known by its hashtag, IndyRef2. Polls show Scots don't want it. Voters said as much when they took away Sturgeon's majority at the last Scottish election. And now they've reiterated the message, flocking instead toward unionist parties. Sturgeon seems to have received the message, saying IndyRef2 was "undoubtedly" behind her electoral failures and hinting she'll back off. Whether she does or doesn't, it seems fairly clear Scots don't have much appetite for independence at the moment, which should abate the uncertainty lingering over Scotland since Scots voted against Brexit last year. At the time, some feared Scotland's being forced to Brexit by the English and Welsh could tip voters fully toward independence, preferring union with Europe to union with fellow Brits. But now that looks highly unlikely, giving investors one less thing to fret.

The Polls Were Sort of Right. And Not Helpful.

Considering the last round of polls showed the Tories leading by anywhere from 1 to 13 points, it's pretty clear pollsters fixed the issues that plagued them in 2015, when they overestimated Labour turnout and underestimated Tory turnout. But some clearly overcorrected, underestimating the youth vote-and young voters are what swung the pendulum toward Labour. YouGov and Survation were the most accurate, while others have some work to do.

All that said, in the end, the Tories won about 42.5% of the vote, while Labour took about 40%. Both figures were within the margin of error for most polls. Most polls also nailed the Liberal Democrats' 7.4% showing right on the nose. Yet none of it really helped investors handicap the outcome, because the UK doesn't have proportional representation-they vote by constituency, using a "first past the post system" where whoever gets the most votes takes the seat. No runoff, no counting second or third preferences. This is how the country prefers it: A referendum to change to proportional representation, held in 2011 at the Liberal Democrats' insistence, failed with a resounding thud. But it makes gleaning anything useful from polls difficult even when they're right, as constituency-specific polls are few and far between. Pollster Lord Ashcroft tested a new seat-by-seat model using polling trends and demographics to estimate every constituency's result, but it showed the Tories winning between 351 and 373 seats. YouGov pretty much nailed it with a May 31 analysis projecting 317 seats for the Conservatives, but when a couple polls showed the Tories up 8 points a few days later, confirmation bias drove much of the investing world to presume May & Co. had it in the bag.

The lesson: Don't base investing decisions on polls alone-or presumptions about stocks' short-term reaction to any election. Stocks move on policies, not personalities, and the swing factor is always gridlock. For all the fear of a minority government, the FTSE 100 rose 1% on Friday and the domestically focused FTSE 250 rose 0.13%.^[iii] The pound's overnight plunge sparked some chatter, but as we write, sterling is trading at $1.27. The day before May called the election-April 17, it was at $1.28.^[iv] So it seems fair to say the election's net impact on the currency is basically nonexistent.

All the opinions and rumors that drive markets over short periods are fickle. Longer-term responses are usually more gradual and based on the likelihood of fundamental change. There is always plenty of time to figure that out after the results are in.

Brexit, Brexit, Brexit

Is happening, of course. But will it be "hard," or will it be "soft"? May has spent the past few months pontificating in favor of what many consider a hard Brexit, without free movement of people and a willingness to finalize a divorce without a trade agreement. But the DUP, though staunchly pro-Brexit, is dead-set on a softer approach. Last night, Foster told the BBC she wants to ensure there is no "hard border" between Northern Ireland and the Republic, with folks still free to live in one and work in the other. Speculation is rife that May might have to soften her approach to secure the DUP's support-nevermind the fact Labour, which wants a soft Brexit, is nipping at her heels. But May isn't exactly changing her tune yet.

While Brexit-related uncertainty thus persists, it's hard to argue uncertainty is materially higher than it was 24 hours ago. May was always going to have a difficult time getting any exit agreement through Parliament, given the varying views among her backbenchers. Labour and the Liberal Democrats were always going to try to influence the negotiations. All involved were probably always going to have to make concessions. Maybe May has a slightly harder time securing a final deal than she otherwise would have, but it's too far in the future for investors to handicap now, particularly because ...

There Could Be Yet Another Election

It's a distant possibility for now, but yes, another snap election isn't out of the question. Minority governments frequently don't last long. Labour PM Harold Wilson's lasted just seven months in 1974. If May's government falls and no one can get together enough votes to form a new one, we could do this all over again. Maybe not right away, but five years is a long time to try to sustain a weak administration, and if the Tories lose a few by-elections, even the DUP's support might not be enough to carry on. This shouldn't impact UK markets or investment decisions now, but still, food for thought.