True Views: General Election 2017: Beyond Strong & Stable.

The UK General Election of 2017 took place last week. Here is True’s perspective on the outcome:

Last week’s General Election provides the most interesting raw materials for psephology in decades. When Theresa May called a snap General Election seven weeks ago the political risk:reward appeared heavily skewed in her Government’s favour; the local and by-election results provided the strongest outcome for an incumbent governing Party in a generation and the widely-held view (at local party level, as well as in the Westminster “bubble” and supported by all polling data) was that Labour’s leadership stance left the party exposed to a damaging, potentially catastrophic, reversal.

The subsequent increase in support for Labour will be subject to a huge amount of analysis, but the principal and most plausible explanations for the expectation-defying result include an anaemic, borderline complacent campaign from the Conservatives characterised by an unwillingness to engage in policy debate and apparently reliant on an expected self-implosion by Labour. The campaign included notable mis-steps (most damagingly the “dementia tax” manifesto pledge and U-turn) which undermined the Prime Minister’s central tenet of “strong and stable leadership”.

Labour’s campaign, while far from flawless (indeed it threatened to disintegrate in self-parody in the early weeks, as senior figures grappled with the stretched arithmetic of the funding of manifesto pledges), clearly resonated far more with the electorate than was anticipated or, for the most part, had been identified in the opinion polls. A willingness to engage in open debate around policy issues contributed to a perception of authenticity, while the overarching campaign message of “ending austerity” and placing increasing fiscal burden on corporations and the highest earners met with enthusiasm with larger elements of the population than received wisdom had anticipated.

To this end, one perspective on this election (which might also apply to last year’s EU referendum) is that outperformance (and this is relative to expectations as the Conservatives did win 56 more seats than Labour, after all) was delivered by the Party offering a more “positive” vision of the future with change at its heart. The UK population has become understandably weary of the cadence of domestic politics and economics; too many elections, too much austerity, too little hope for or vision of improvement. In our view, this somewhat emotive factor may have been as significant in General Election 2017 as the widely-reported “backlash against Brexit” which is somewhat hard to square against a distinctly muted performance by the Liberal Democrats at the ballot box.

Turnout statistics also hold clues to the wild mis-match between the local and General Election outcomes, with much higher participation at the national level reflecting the mobilisation of younger voters who, as a cadre, are more committed to pursuing a Remain stance on Britain’s position vis-à-vis the EU and, accordingly, took strongly against the Government’s “Brexit means Brexit” rhetoric. Consideration will doubtless also be given to the impact of the recent terrorist attacks on voter intentions, although we would judge this to be speculative.

What next?

Politics

The UK political landscape is now in a state of almost unprecedented flux. Little real clarity has emerged in the last few days, with moves towards the establishment of a fragile-looking alliance between the Conservatives & the DUP the major development to date. The divergence in the political ideology now represented at Westminster (with Labour having moved definitively to the left under Jeremy Corbyn’s leadership and Theresa May’s Conservatives edging to the right) and the recent, not entirely harmonious, history of coalition government together with the raw arithmetic of the seat-split by Party makes the creation of a stable Government with Parliamentary (let alone popular) authority highly elusive. Another General Election in the near term (within the next 12-18 months) is extremely plausible, even probable with economic conditions likely to become increasingly hostile for the incumbent Government as real wage declines begin to bite.

Brexit

In this context, the imminent prospect of the UK commencing Brexit negotiations with the EU is troubling to say the least. It is impossible to predict with any confidence what the composition of the Government will be over the course of the next two years, let alone its objectives regarding the negotiations. Both major parties have stuck to the line that the democratic will of the British people (as delivered by last year’s referendum on EU membership) will be respected and this has been endorsed by Parliamentary vote hence the high likelihood remains that Brexit will proceed.

Some commentary has suggested that the Conservative Party’s setback at the Election increases the probability of a “Soft Brexit”, on the basis that the Government will need to moderate its relatively hard line as regards its opening negotiating stance (“No deal is better than a bad deal”) with the EU. This may be so, but the notion of the UK being able to negotiate a “better” settlement under current chaotic conditions than with a Government with a clear mandate appears highly questionable.

Economic

Whereas the Brexit vote a year ago had, in our view, clear (negative) consequences for the macroeconomic backdrop in the UK, the outcome of this General Election is, notwithstanding the comments above regarding the bedlam at Westminster, probably of rather less relevance for developments in the economy. As ever, the best (and easiest) litmus test is to observe the judgement of the currency market and the snap view through that prism is that this represents a negative outcome with Sterling immediately falling around 2% against both the US Dollar and the Euro. A longer term perspective provides more nuance, however, with Sterling still trading above levels reached in the aftermath of the Brexit vote. Economically negative, but not disastrous, in other words.

Our own macroeconomic research has, for some time, indicated a darkening of the economic skies in the UK and the negative trajectory we expected following the Brexit vote (caused principally by rising inflation as a function of Sterling’s devaluation) has largely transpired. Looking ahead we remain cautious on the economic outlook; inflation continues to rise as the dampening effects of currency hedges progressively unwind, consumer confidence is brittle, and the labour market which has been the engine of economic recovery following the financial crisis has minimal scope to provide ongoing stimulus.

The net effect is that consumers are, on average, experiencing real wage declines having already suffered the longest period of stagnant living conditions since the Napoleonic era. An historically low savings ratio and double-digit growth in consumer credit provide further cause for concern with a clear sense that the UK consumer has only a limited safety net in the event of an adverse shock (for example, a sustained rise in unemployment).

The Retail & Consumer Industries and Our Investment Focus

Structural changes in consumer behaviour, driven primarily by demography and technology, provide additional challenges to incumbent operators in the retail and consumer sectors, particularly those over-indexed to above-inflationary increases in key costs such as labour and property. Channel shift towards online operators continues apace – indeed recent data suggest the growth arbitrage between on and offline is widening – hence we remain confident that our investment focus on assets exposed to structurally growing channels with lean cost structures and supply chains, capable of capitally-efficient scaling and with brand-enhanced control of margins is highly appropriate.

A further observation merits consideration. One feature of the post-crisis recovery in the UK (and elsewhere, notably the US) has been a flattening of the country’s productivity progress. This has coincided with the imposition of ultra-loose monetary policy (via historically low policy interest rates and QE) and we are minded to concur with analysis that suggests the two phenomena are linked. In short, monetary stimulus post-crisis has provided a barrier to the “creative destruction” which normally occurs in periods of economic distress. There are positive implications to this – monetary policy has, in this regard, protected the labour market (i.e. defended jobs) – although the support of “zombie” companies and industries is of dubious long term benefit.

To paraphrase the Nobel Laureate Paul Krugman, in the end productivity is the most important factor in driving higher living standards in any economy. The silver lining to the dark economic clouds, and solace to be taken from an uptick in corporate administrations, is that this period of painful adjustment may sow the seeds for a recovery in productivity trends and offers increasing opportunities for capital deployment in business models structured to exploit emerging trends.

True will continue to seek opportunities in these areas for the benefit of all stakeholders.

13 June 2017