What’s Really at Stake in the UK General Election?

As always, our political commentary is nonpartisan. We favor no party or candidate and assess politics solely for its potential market impact.

Less than a week before the UK's general election, a bevy of conflicting polls suggest the Conservatives' hold on Parliament could fade or disappear. Headlines claim markets (and the pound) have already priced in a substantial Conservative victory, and will tumble if disappointed. Our advice: Keep cool, and think longer term. Like any contest with wide polling discrepancies, the outcome is impossible to handicap. While sentiment might make stocks swing higher or lower in the immediate aftermath, in our view, how policies-not personalities-impact markets over the longer term matters more, and this largely depends on how much legislation the next government is able to pass.

When Prime Minister Theresa May called snap elections in mid-April to strengthen her hand in Brexit negotiations, Conservatives seemed poised for a landslide win. Since then, the gap has narrowed. Some polls still show Conservatives winning comfortably, but others put Labour within the margin of error, suggesting a hung parliament. May made some gaffes, like proposing and then pulling an ominously labeled "dementia tax" and repeating "strong and stable leadership" at every turn. Meanwhile, Corbyn's message gained traction, especially among young voters, despite high-profile party members' occasional difficulty explaining how they planned to pay for everything. Though all polls show the race tightening, none show Labour leading. But there is a growing suspicion that Labour leader Jeremy Corbyn could be the one Queen Elizabeth asks to form her next government.^[i]

Polls' notorious recent inaccuracies fuel this suspicion. Most polling agencies overestimated the "Yes" vote in Scottish independence referendum and missed the Conservatives' big win in 2015, and some were wrong again about Brexit. A postmortem on the 2015 election polling last March suggested (among other things) pollsters were overestimating young turnout and misjudging undecided voters' leanings. They responded with varying methodology changes, putting UK polling in a state of flux and making it impossible to say which surveys are right. As YouGov's Anthony Wells put it, "From the pollsters' point of view this is an experimental election."

On June 9 we'll know how their real-time science experiments fared. Until then, we believe investors should take everything with a grain of salt, and think like markets: Consider all possible outcomes, and the likelihood the next government-whatever form it takes-is able to pass radical legislation. Obviously, either party could win a majority. But there are plenty of funky alternatives. If Conservatives win the most seats but lose their majority (the minimum is 326 seats), they could attempt to form a coalition with Northern Ireland's Unionist parties or the Liberal Democrats. But potential partners would have to win enough seats, and in the Lib Dems' case, be willing to rejoin a coalition that destroyed their goodwill with voters in 2015. Failing a coalition, Conservatives could try to form a minority government-tenuous, but it has happened. Labour, too, could try to form a coalition with the Scottish National Party or Lib Dems. Corbyn has both played down and hinted at this possibility, further muddying the waters.

However, investors needn't agonize over which party will supply the Prime Minister. Despite longstanding reputations, no party is inherently good or bad for stocks. Labour and the Conservatives have each passed laws one could consider pro- and anti-business, and their current manifestos contain pledges that give many investors the heebie jeebies. The Conservative version espouses energy price caps and limits on foreign M&A while tacitly threatening tax hikes. Labour's calls for undoing corporate tax cuts, banning fracking, restricting labor markets and re-nationalizing railways. Hence, if either party won a strong majority, markets would have to grapple with higher legislative risk. But a slim majority would tie the winner's hands and promote gridlock, particularly with Brexit talks distracting for the next couple years. A minority or coalition government would struggle even more to implement its agenda. The Conservative/Lib Dem coalition from 2010-2015 didn't do much, and most legislation that did pass was watered down from initial proposals. UK stocks, meanwhile, did fine.

This shouldn't surprise. In economically competitive countries, stocks prefer gridlock: It slows, dilutes or kills disruptive legislation. We suspect this is a key reason that of the five developed European countries with minority governments (Spain, Ireland, Italy, Denmark, Norway), all but commodity-heavy Norway are outperforming the MSCI World Index year to date. (As has the Netherlands, which probably joins the club soon.) A weak UK government would likely provide UK stocks similar relief over time, as businesses won't have to fear the rules changing bigly.