13 Jun Be Sure of Your Numbers…
It has been said that one of the first lessons in leadership is ‘to make sure your numbers add up’. The irony of this is not likely to be lost on Theresa May who, just as her predecessor David Cameron did with the referendum on Europe, took a gamble which backfired spectacularly. In both cases they overestimated their support but there are compelling reasons why leaders cannot possibly know their numbers.
Once again the opinion polls in the run up to the election were found to be egregious, so before we get into what this all means for investors, it is probably worth a look at the fallibilities of polling. The first is sampling error, which we have touched upon before. Random sampling is used for a variety of purposes, of which elections are one of the most prominent. For estimates to carry any degree of validity, the samples from which they are drawn need to be as reflective of the wider population being measured as possible.
In its infancy, the extent of the difficulties in polling was not well understood. In 1936 the Literary Digest conducted a survey of the voting attentions of 2.3m people in the US and predicted a landslide victory for the Republican candidate Alf Landon. The result was indeed a landslide, but it was Franklin Roosevelt that won every state with the exception of Maine and Vermont. The problem was that the sample, whilst statistically robust, was drawn only from the magazine’s subscribers, woefully unrepresentative of the American population at the time. The Literary Digest closed for business shortly afterwards.
The other issue with sampling is response pattern. In other words, does the voting intention actually play out on the ballot paper ? This can be influenced by the type of question being asked. For example, a poll to ascertain people’s consumption of milk, is more likely to be accurate than one measuring their alcohol intake ! It is not uncommon to find spurious results even when the question asked is straight-forward, such as milk and alcohol consumption. Or the choice of remaining in or leaving Europe, as we saw in June 2016. But when the composition of government depends on the complexity of disparate constituencies, the accuracy of polls can be very hazy.
If we are charitable, we might be able to accept the difficulty Mrs May would have in making sure her numbers would stack up. But the entire premise of the recent ‘snap’ election was to secure a larger majority for the Conservatives, to be used as a springboard for entering Brexit negotiations from a position of strength. With the Conservatives securing just 318 seats, a loss of 12, her bargaining position is now considerably weaker. Indeed it is now only courtesy of an alliance with the Democratic Unionist Party (DUP) that she can maintain an overall majority at all.
The immediate market reaction to the result was muted. Stock markets were barely changed but this is likely to be because investors were trying to evaluate all possible permutations. As the results emerged, the press used sensationalist phraseology such as ‘sterling plummets’. In fact sterling fell by around 2%, still a sizeable movement, but not uncommon and only taking it back to a level last seen in April.
This weekend saw Mrs May reshuffle the cabinet and whilst the return of Michael Gove is eye-catching, it was notable for very little else and definitely defensive in nature, which is hardly surprising given her tenuous position. The bigger question is perhaps whether she can continue as Tory leader. Former Chancellor George Osborne certainly doesn’t seem to think so, but a leadership challenge and a return to the polls would be another huge gamble, especially given a resurgent Labour party.
With Theresa May’s weakened mandate and dissention within Tory ranks, the new administration will need to adopt a more stimulative position, possibly borrowing and spending more. This is likely to be positive for the UK economy and most certainly for equities. Whilst there is no immediate likelihood of a rise in interest rates, the perception of more expansionist fiscal policy, would be detrimental for bonds.
If the Conservatives can forge a working relationship with the DUP, they will likely have to offer some concessions, which could include membership of the EU Customs Union, but whatever form these take, the ‘hard Brexit’ feared by financial markets is likely to be moderated. With David Davies remaining as Brexit Minister, it appears likely that negotiations could start as early as next week but are not likely to decide anything material until after Germany’s elections in September, meaning there is plenty of time for the UK’s political dust to settle.
So, what does all this mean ? We conclude that many questions remain unanswered but if we are to see a ‘softer’ Brexit and a more accommodative policy, this should be more positive for equities than bonds, fully reflective of our stance across all CDC portfolios at the moment. Whilst the weakness in sterling has made the headlines, as 70% of FTSE 100 earnings are generated overseas, this actually provides a useful tailwind to larger UK companies, further advocating our overweight position. Second line stocks with a more domestic bias though such as those within the FTSE 250 or 350 will benefit less from this.
Thus from a macro position, we believe we are sensibly positioned but one question we are debating at the moment is if sterling weakness is likely to be a more prolonged phenomenon, perhaps as a result of a leadership challenge or a weaker bargaining position with Europe, whether we should tilt our equity exposure away from the UK, in favour of international. We will be monitoring events closely and shift the emphasis if we see an opportunity.