What does the June election mean for the UK and UK assets? If current polls are used as a predictor, Theresa May will secure a much larger majority in parliament than she currently has. She will also push back the deadline for the next election by two years to 2022.
Longer time frames and greater support should mean greater power for the prime minister. With a larger majority, she will be less reliant on the hard-line Brexiteers within the Conservative party; those who want a clean break from the EU by 2019, no matter what the economic cost. A large majority would empower her to face down this faction and agree to the terms the EU will demand in return for a transitional arrangement – the most sensible option given the scale of the challenge ahead. The EU has made clear it is open to a transitional arrangement, lasting up to three years after the official Article 50 deadline expires, in March 2019.
More time will not diminish the unavoidable logic that Europe cannot indefinitely permit the UK to fully maintain its existing free trade arrangement with the EU, while also leaving and regaining control of its borders and laws. So the UK's eventual trade deal with the EU must, as a result of Brexit, end up worse than it currently is. But that is not to say more time would not be helpful. Breathing room gained by a large general election victory could provide time to negotiate a deal that is not economically as good as the current one for the UK, but is much better than no deal, for both sides.
This could feasibly include free trade in goods, but almost inevitably not in all services. However, the extra three years could also give those businesses, which will be required to adjust and relocate staff, time to deal with some of the practical and logistical challenges involved.
While no cure-all, the election could decrease the risk of a no-deal outcome and buy time for businesses to adjust. For UK investors, the clearest implication is that near-term risks are potentially reduced for the economy. If a transition period can be agreed, this could improve business and consumer confidence. In this environment perhaps sterling does not deserve to be quite as cheap as it has been since the referendum.
But if the weakness in sterling since the referendum, which drove up the value of the foreign revenues of large UK companies and with it their share prices, partially reverses, this could put pressure on UK equities. It could lead to companies with the highest foreign revenues underperforming the more domestic focused stocks and, by extension, small and mid-cap stocks outperforming the larger, more internationally focused firms.
At the margin, slightly lower economic risks also suggest government bond yields could trade higher. However, it could also support corporate credit spreads making credit more attractive than government bonds.
That said, the huge uncertainty facing the UK is very unlikely to disappear soon, even if the near-term risks do end up reducing somewhat after the election. The path for sterling, UK gilts, credit, UK equities, the relative performance of different sectors – and of large relative to smaller companies – is still far harder to predict than usual. In this environment, relative to benchmark, smaller active positions make sense within UK assets.
In the past, taking large active sector and size positions within UK equities has paid off handsomely for fund managers, driving long-term outperformance. With all the political uncertainty ahead, fund managers who focus on stock selection over size and sector preferences are less likely to get caught out by surprise political announcements.
Nandini Ramakrishnan is global market strategist of JP Morgan Asset Management
