The UK Gets a New Prime Minister
Well that was fast! The race to replace David Cameron was supposed to last another nine weeks, as Home Secretary Theresa May and Energy Secretary Andrea Leadsom duked it out in the Conservative Party’s leadership contest. But Leadsom dropped out suddenly over the weekend, after contracting a case of foot-in-mouth disease[i], leaving May with the prize. Cameron will hand his notice to the Queen after Prime Minister’s Questions on Wednesday, May will start her move into 10 Downing Street that evening, and Cameron will go gentle into that good night while perhaps humming a jaunty tune.
May has two main tasks: uniting the Conservatives after a rough Brexit campaign, and overseeing Brexit negotiations. To accomplish the former—and perhaps win over all the Tory voters eyeing UKIP’s populism—she has suggested requiring corporate boards to include workers and consumers and cracking down on foreign acquisitions of UK firms. Pundits are a-tizzy, as these aren’t exactly stereotypical Conservative proposals, but we wouldn’t get too caught up in them. Whether you love or loathe these and other ideas, politicians often talk big, then moderate—especially when they preside over gridlocked legislatures, as May will. The Conservatives’ majority is razor-thin, and those Brexit divisions run deep. Passing significant legislation will be a tall order.
As for Brexit, May has said she’ll wait until next year to trigger Article 50 of the Lisbon Treaty and launch formal exit negotiations. Other EU leaders are urging her to act sooner, but it’s her choice, not theirs. Some suggest she might wait until after next year’s French and German general elections, and we can see the rationale—it would prevent the negotiations from being used as a wedge issue in those campaigns. Regardless of when May triggers Article 50, however, negotiations likely go slowly. Foreign Secretary Philip Hammond estimates it could take six years to finalize the divorce, as all 27 remaining EU member-states’ parliaments might have to ratify the final agreement. This gives markets a long, long time to discover and gradually digest changes well before they take effect, mitigating the potential shock factor.
Overall, May’s promotion eases some of the near-term political uncertainty caused by Brexit, which stocks should appreciate. It also seems the UK isn’t heading for a snap election, despite calls from Labour leader Jeremy Corbyn and Liberal Democrat leader Tim Farron. May declined to call for one—resisting temptation, with the Labour Party mired in chaos—and it would take a two-thirds vote in Parliament to override her.
As for Labour, former Shadow Business Secretary Angela Eagle launched a leadership challenge Monday, and on Tuesday, the party’s National Executive Committee held that Jeremy Corbyn isn’t subject to a rule requiring leadership candidates to have the official backing of 20% of Labour MPs. So he will be on the ballot, but other new rules will bar the 100,000 people who joined the Labour Party after Brexit from voting, and raise the cost of being a “registered supporter” from £3 to £25, potentially limiting pro-Corbyn turnout. The contest’s outcome is unknowable today, but also not a major issue for stocks now. The Labour Party’s leader and platform will be an issue for the next election, likely in 2020, but until then, it won’t have much impact on policy—and stocks care about policies, not personalities. Resolving the contest should help clear up more of the lingering uncertainty, but that’s about it.
Australia Gets the Same Prime Minister
Eight days after Australia’s closely contested election—and with officials still counting the last few votes—Prime Minister Malcolm Turnbull claimed victory Sunday after his rival, Labor Party leader Bill Shorten, conceded. Turnbull’s Liberal-National coalition won 76 seats, versus 69 for Labor and five independent/small parties, giving them the thinnest of majorities. Turnbull, who ousted former PM Tony Abbott one year ago, gambled by calling a snap election in hopes of breaking gridlock on his reform agenda. Instead he likely got more, not less gridlock, as his coalition lost seats and still faces an opposing upper house.
While gridlock is usually bullish in competitive, developed nations like Australia, politics are only one driver. Australia’s markets and economy are heavily weighted toward commodities, which face headwinds from excess supply and decelerating Emerging Markets demand. While the fact that Australia’s political revolving door—which was starting to rival Japan’s—didn’t turn again might boost sentiment a tad, that probably isn’t enough to overcome the rather lackluster economic fundamentals for now.
That being said, the Australian punditry is all atwitter over the news S&P put the country on notice for a possible downgrade from its current AAA, largely based on the revolving door and elevated deficits. This is a false fear. Many suggest the loss of its AAA would send yields spiking, and potentially risks a financial crisis. However, we’ve seen this movie before, and we are here to tell you that when high-rated sovereigns are downgraded, lower rates typically follow—not higher. We just saw this again in Britain. And we are betting Australia, with its 18.9% net debt to GDP ratio and 1.9% 10-year yield isn’t likely to be an exception.[ii] While Australia’s near-term outlook isn’t robust tied to Materials and Energy exposure, it isn’t a crisis in the making based on a dodgy potential downgrade from an outfit that calls its own analysis, “marketing hype” when pressed.
Japan Gets More Talk
Finally, in Japan, Prime Minister Shinzo Abe’s Liberal Democratic Party (LDP) and its coalition partner, New Komeito, won a resounding victory in Sunday’s upper house elections. They now have a two-thirds majority in both houses, increasing the likelihood of a new fiscal stimulus package. As he often does, Abe discussed stimulus in his election-night speech, though he didn’t offer details on size or scope.
More noteworthy, this election potentially sets the stage to reform Japan’s pacifist constitution, which limits Japan’s military to defense. Revising Article Nine—the anti-war clause—is one of Abe’s lifelong ambitions, and it looks Abe finally has the required two-thirds vote in both houses to move the process forward. It isn’t certain, as New Komeito is a pacifist party, but many believe Abe does have enough backing. If the revision were to pass, it would go to citizens in a national referendum. Yet the public overwhelmingly disapproves of the idea, so it seems unlikely Abe would plow ahead in the near term—however, this issue likely remains a distraction, as it has been for his entire premiership, taking the focus off actual economic reform.
Other than that, the election doesn’t change much in Japan, which remains in dire need of economic reforms to make labor markets more competitive and corporate governance more effective. These reforms have continually proven more difficult to enact than anticipated, and having a few extra seats in the upper house probably won’t make much difference. The Abe administration has enjoyed majority control in both houses for several years, yet it repeatedly favored insufficient monetary and fiscal measures over significantly more beneficial structural measures. With Abe already jawboning about stimulus, it’s hard to see that changing now. Absent reform, we continue to believe better opportunities lie elsewhere for global investors.
[i] This is a strain common to politicians.
[ii] Source: FactSet, as of 7/11/2016.