London stocks await election fate at high valuations

So much for political uncertainty derailing UK shares, at least for now.

Three weeks into a closely fought election campaign, and London's main equities indices have reacted to the prospect of a hung parliament and a fresh round of coalition building with a pinstriped version of the famous Gallic shrug.

London's FTSE 100 even touched fresh record highs during the campaign, closing at 7,096.78 on April 15. The mid-cap FTSE 250, seen as more representative of the domestic UK economy, also closed at a record on the same date, reaching 17,873.53.

With stocks across the eurozone buoyant, helped by the European Central Bank's economic stimulus programme, are London's main equities indices set to carry on rising with the tide, or do current elevated levels look vulnerable to any political uncertainty in Westminster after the May 7 polling day?

The share market faces challenges irrespective of whether the Conservatives or Labour lead the next government say investors, with the banking, utilities and property sectors seen as being vulnerable to a highly charged political environment.

"I'm surprised how comfortable the UK equities market is at the moment, looking ahead to some pretty frightening coalition prospects," says Rebecca O' Keeffe, head of investment at Interactive Investor.

"The election has the capacity to set up some combinations that will not be supportive, especially to mid-cap stocks. Companies which derive the bulk of their income from the UK and are more reliant on the support seen from the government and central bank could find that life is much less rosy under a different coalition."

According to a poll undertaken for this article by Interactive Investor among its 1.5m user base of retail investors, 47.4 per cent of more than 8,600 respondents expect financial stocks to suffer most in the remainder of the run-up to the election.

"Banks could be a turbulent space with everything from the re-privatisation of Lloyds under the Tories through to bankers' bonuses and cracking down on tax measures," says Jeremy Steinson, head of trading at Killik.

The role of London as a global financial centre for the eurozone, however, dominates the election chatter in the City.

Ms O'Keeffe points to the Conservatives' policy of an in-out referendum on the UK's EU membership, warning that "the prospect of the country leaving the Union, could damage the status of the City of London as a global financial centre".

Analysis from Morgan Stanley adds weight to this view: "The prospect of a 'Brexit' referendum would weigh on banks, financial services and property in particular."

Such remarks echo the sentiments of a letter sent last week to the Financial Times and signed by 55 UK businessmen.

Graham Secker, European equities strategist at Morgan Stanley says: "If the Conservatives were to form another government with the Liberal Democrats, where the price of continued coalition was the cancellation of the proposed EU referendum, this could be viewed more favourably."

Beyond the banks, the Interactive survey also highlights worries over utility stocks, with the sector at the centre of Labour plans to cap energy prices, with 18.6 per cent of the vote. Property stocks came third, with 12.6 per cent.

Analysis from Morgan Stanley concludes that "a Labour-led administration [is] a potentially negative outcome", citing the party's "proposed increase in intervention, particularly in transport and utilities, and a higher risk of further regulation".

Then there is the housing sector, against the backdrop of high property costs and various policy solutions.

Mr Steinson says housing stocks are a key area to watch after the election and he expects some volatility in the sector depending on which of the major parties has the most seats.

"It's rather a split area with the potential of increased right to buy, brownfield sites being pushed through planning, or the punitive mansion tax for Labour.'' He adds: ''Labour's mansion tax could be vastly punitive looking at developments currently in process. Foxtons, the London-focused estate agent, could be a possible dramatic loser, one of the most exposed to the mansion tax.''

Whatever the outcome of the election, there are factors beyond the reach of Westminster that look supportive for UK stocks, mainly a lower pound against the dollar.

According to data from Capita Asset Services, FTSE 350 companies issued a total of £14.75bn in dividends in the three months to the end of March. The capital return, from ordinary as well as special dividends, includes the amount paid from the 53 constitutents that pay out in dollars and was boosted by the strength of the US currency in the period.

Graphic courtesy of Morgan Stanley Economics & Strategy

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