Calm is good

Politics were very much centre stage last week. But as is usually the case for markets at least, the economics turned out to be more important. Even so, it would be a travesty and just plain weird not to give our take on the latest political developments – although more than enough has arguably already been written on the subject.

First off then, the UK. Markets basically shrugged at the news of Labour winning a stonking majority. UK equities and bonds both ended the week up 0.5-1%, little different from the moves seen in other markets. As for the pound, it too was becalmed, rising all of 0.5%.

The lack of reaction was partly because the result was hardly a big surprise. But it was also because (as we highlighted in our recent Election Special) economic policy at the end of the day was never going to be that different, under Conservatives or Labour. The big hope now is that a period of stability, along with a relaxation of planning controls, will boost private investment and ease the infrastructure shortcomings which have been a major factor holding back growth.

We retain our positive outlook on the UK market. The No. 1 reason is its cheap valuation but the improved growth outlook is also a factor and a reason why we favour small and mid-cap stocks over large cap. Indeed, these areas outperformed last week.

Labour could certainly end up increasing capital gains tax given its need to raise money and it ruling out rises in the big four taxes – namely income tax, national insurance, VAT and corporation tax. But with foreigners owning 60% of the market and a good part of domestic holdings held in vehicles where CGT is inapplicable, this should not pose a significant drag.

Moving onto France, the cunning plan by Macron’s centrist party and the leftwing coalition, to drop candidates in the second round of the election to squeeze Marine Le Pen’s far-right party, ended up working rather too well. Rather than the far right ending up with the largest numbers of votes as had been expected, instead the left did. And their policies are arguably even less palatable to the market than those of the right.

But crucially, they did not gain a majority, so we are now looking at a minority government and a period of ‘cohabitation’. The composition of any coalition remains unclear and the prospect is most likely to be policy paralysis rather than anything radical.

As for the market reaction this morning, it was limited. French equities, along with other European markets, are up 0.5% or so. However, France has underperformed by over 5% since Macron called the snap election and looks unlikely to claw this back any time soon.

Next, there is the US. Calls from senior Democrats for Biden to withdraw from the Presidential race have grown louder but the President has said only the Lord Almighty could convince him to quit. The markets currently put the odds of a Trump victory at 55% with the chance of a Biden or Kamala Harris win placed at 16% and 15% respectively.

The last political event worthy of a mention is the news from Iran that the reformist Pezeshkian unexpectedly defeated his hard-line conservative opponent in the Presidential election. Ultimate power still very much lies with Ali Khamenei, the supreme leader. But at the margin, this clearly represents some reduction in geo-political risk with Pezeshkian promising re-engagement with Europe and the US.

Enough on politics. Global equities ended the week up 1.8% and 0.7% in local currency and sterling terms respectively and bonds also saw gains of 0.5-1%. The driving force here was some weaker than expected US economic data.

Business confidence undershot expectations in June and more importantly, payroll gains in recent months were revised down, more than offsetting a slightly larger than forecast gain for last month. Meanwhile, the US unemployment rate edged up to 4.1%, a 2 ½ year high, and wage growth slowed a little further.

The data were not weak enough to trigger any alarm about a recession but do potentially give the green light to the Fed to cut rates in September and the market accordingly is now pricing in two cuts by year-end.

As has been the case all year, the ‘Magnificent Seven’ tech stocks too played a role in last week’s market gain, rising some 7%. This time, it was led by a 27% rebound in Tesla’s share price, on the back of higher than expected deliveries in the second quarter, which has now recouped its losses earlier in the year.

This coming week, the highlights will be Powell’s testimony to Congress on Wednesday, the US inflation data on Thursday and the kick-off of the second quarter earnings season with the big US banks on Friday.

Rupert Thompson – Chief Economist