If nothing else, the UK general election confirmed the need always to approach surveys cautiously. The Conservatives won a majority of seats in Westminster, meaning a change of government if not a change in prime minister or chancellor. The most important policy commitment for financial markets is that by the end of 2017 the UK will hold a referendum on its place in the European Union.
The initial market reaction to the Conservative majority has been positive. Sterling has risen against the dollar and equities are up significantly. Markets loathe uncertainty and fears that the outcome would be inconclusive have seemingly come to nought. A majority for any party would have been treated favourably, but a Conservative one particularly so as it implies that the current mix of tight fiscal and loose monetary policy is set to continue.
A Tory victory means that the economy will have to endure a fairly aggressive renewal of the fiscal squeeze; which will no doubt reassure the gilt market. However, this initial market euphoria is unlikely to last as markets wake up to the realities of a Brexit referendum. Meanwhile, the success of the SNP suggests that Scottish independence could also come back onto the agenda. Under normal circumstances, I would expect that this would lead to a rise in the risk premium on sterling assets, however with cheap cash continuing to flood the markets I do not believe this will have any material impact.
On the economic front, the UK cannot insulate itself from global economic and political events. In no particular order the on-going problems in Greece are still with us. The timing of the first interest rate rise in over six years is likely to rear its head again, especially if the US moves first. The US elections and the potential ramifications of foreign policy changes, at a time of heightened political uncertainty across the developing world, is also one for investors to be keeping a close eye on.
However, none of this is too worrying. The Conservatives may find cutting spending as much as they want hard to achieve anyway. Meanwhile, investment in Scotland held up well in the run-up to the independence referendum there last year. And the UK’s fundamentals otherwise look pretty good. Ultimately, the tight Tory fiscal plans make it more likely that interest rates will stay lower for longer.
In last month’s column, I discussed my concerns of illiquidity within the bond markets. I did not however expect to see this come into fruition as quickly as it did. To reiterate the point, the debt markets have been completely manipulated by the new rules of the Central Banks and liquidity will be particularly dry as shocks hit the market. This is an opportunity for commercial property investors, who are being richly rewarded for the property risk premium over and above the corporate spreads. Conversely, if the illiquidity in the bond markets self-perpetuates into the beginning of the end of the bull market, yields will rise quickly, and the disparity between real estate and other asset classes will not be that attractive.
“Those who have knowledge, don’t predict. Those who predict, don’t have knowledge” were the famous words of Chinese poet Lao Tzu; a potent reminder in a week of prediction defiance. The savvy investor is not betting on predictions, rather managing the risks inherent in assets. For this group UK commercial property is compelling to say the least. For those betting on predictions of continued yield compression, there are better opportunities in other asset classes.
The Conservative victory means that there are upside risks to the housing market. The chancellor George Osborne has already tinkered with the housing market many times. The most telling of these policies was the Mortgage Guarantee Scheme, which helped to boost house price inflation into double digits. Over the next five years, the Conservatives may well do more in an attempt to boost housing demand. It is noteworthy that share prices for house builders and estate agents have reacted positively to the election result. Needless to say, London will be the major beneficiary with Labours threat of a mansion tax and crack-down on non-dom status no longer a threat to residential property investors.
Michel Heller is a fund manager at Strawberry Star
