The UK general election result provided another shock to most observers, just under a year after the UK’s decision to leave the EU.
The Conservative party lost its parliamentary majority, forcing Theresa May to create a minority government with the support of the Democratic Unionist Party to ensure “certainty”.
Commentators balked at this, including former Conservative chancellor George Osborne, who described her as a “dead woman walking”.
Although it is traditionally accepted that financial markets don’t like uncertainty, early reactions suggest market participants are more used to political turmoil.
In addition to the Brexit negotiations, UK investors must deal with political uncertainty in the coming months. Perhaps these investors could learn from their continental peers, who have coped with the eurozone debt crisis and political unpredictability during the past few years. Belgium, for example, holds the world record for a democracy going without an elected government, which went on for 589 days in 2010-2011.
I decided to study three periods where political uncertainty has occurred in the EU. The first period to highlight is the first eurozone sovereign debt crisis, which lasted from April to September of 2010.
One year later, this episode escalated with the talks around a second bailout for Greece – which was finally agreed at the end of September 2011.
The last study period ran from March to May of 2012, which saw fears that Greece might exit the eurozone and Spanish banks were under threat.
Over those three periods, the FTSE World Europe ex UK index lost 14.7 per cent on average (in euro terms). It fell by 21.1 per cent between July and September 2011 when debt holders failed to reach an agreement on Greece’s second bailout.
For equity investors, we could observe that intra-sector correlations increased as market participants did not differentiate between stocks. In other words, getting the industry bets right was more important than getting the right stock. For example, there was a 31.3 per cent difference in performance between the healthcare sector and the basic materials group in the third quarter of 2011.
Overall, it appears betting on the healthcare sector proved to be right. During those three periods of political crisis in Europe, the category generated an excess return of 13.7 per cent relative to the FTSE World Europe ex UK index.
Typical defensive sectors, such as consumer-facing industries, also fared well. Consumer goods have delivered an excess return of 8.5 per cent, while this number stood at 3.7 per cent for consumer services.
Financials, however, fared poorly. This performance is also linked to the nature of the eurozone debt crisis, where investors had expected the entire banking industry to collapse if peripheral countries – such as Greece and Portugal – failed to reach a bailout agreement.
I would also highlight industrials as a poor bet. Although the sector managed to outperform the FTSE World Europe ex UK index by 2.9 per cent in the second quarter of 2010, the group strongly underperformed in the third quarter of 2011 and the second quarter of 2012.
An explanation could be that once the market priced in the potential boost from currency depreciation, market participants took into consideration the cyclicality of the earnings stream.
Maybe that rings a bell here: after the sterling depreciation in June 2016, perhaps investors will revisit the case for UK industrial stocks in the coming weeks?
Charles Younes is research manager at FE
