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Corbyn government and Brexit deal

22 December 2017

How would a Corbyn government impact portfolios?

A Labour government led by Jeremy Corbyn could have a significant impact on UK equity and bond markets. However, with the Fixed-term Parliaments Act now in place, he may have to wait and his chances of gaining a majority are likely to fade as time passes. In September 2018, the boundary commission reports to parliament and there will be fifty fewer constituencies. Jeremy Corbyn's own constituency is due to disappear. It is thought that the proposed changes with constituencies of more equal numbers of constituents will favour the Conservatives. Despite this, with Labour popularity up, we are often asked what the impact would be. There are three broad policy factors to consider: nationalisation, spending and higher taxes.

1. Nationalisation

Nationalisation has a direct impact on the companies affected but also questions the rights of investors. Breaking public private partnerships could lead to a lack of trust, influencing the confidence of investors working with governments. This will depress many individual stocks.

2. Spending

Increased spending will lead to much higher budget deficits and consequently, higher gilt issuance. As a result, we may expect gilts and the pound to sell off. This could bring questions about our credit worthiness and particularly damage foreign investor confidence. The positive side of this may come from the boost to the economy from spending and the fall in sterling making us more competitive in the global market place. The fall in sterling would boost inflation, as it did after the Brexit vote, possibly leading to an increase in interest rates. Some equities with overseas earnings benefit from a falling pound but higher gilt yields will make them less attractive relative to fixed income investment.

3. Higher Taxes

Higher taxes, both for corporates and for the higher paid, are the final major policy impact. Attacking banks and taxing high earners may be a vote winner but may not be as attractive as it seems. High earners and banks will have additional reasons to move out of London into overseas financial centres. If Brexit is not damaging enough to London as a financial centre, this kind of attack could be the last straw. We must remember that London pays more tax than the rest of the country put together. To summarise, contrary to popular opinion, increasing taxes may well reduce rather than increase revenues further damaging the deficit.

It could be argued that Corbyn's tax and spending plans will reduce unemployment and boost the UK economy but, for the reasons outlined above, market reaction is unlikely to be favourable in the first instance. Some equities may benefit from a fall in the currency. Selective UK equity and diversifying overseas will be the way forward for investors concerned about a Corbyn government.

What are the implications of a Brexit deal?

This morning we are waking up to the news that Mrs May has done a deal with the European Union Commission that will allow the negotiations to move to the second phase. This is good news but comes at a potentially significant cost. The Irish border issue that held up a solution earlier in the week has been fudged, with a commitment to keep the border open and for Northern Ireland to remain fully part of the UK. The wording leaves the possibility that we will obey the rules of the single market while being outside it. On finance, we have agreed payments far into the future on existing EU commitments. I have no doubt that the Euro sceptics will want to pick over this in detail but it appears that she has given ground to both the DUP and the EU in an effort to take a step forward. I have no doubts that we will have many more late night negotiations and deadlines before a final deal can be agreed by all parties. The question remains as to what a good Brexit deal could look like and what impact it would have on investment markets.

A good Brexit deal would include a free trade agreement and access for London financial institutions to European markets. The market reaction could see the pound recover some, if not all, of the losses post the Brexit vote. The general consensus is that purchasing price parity is somewhat higher than where we are today. Unfortunately, this is not necessarily good news for investors. A rising pound makes exports less competitive and devalues overseas investments. The FTSE 100 Index has about 80% in overseas earnings that would be reduced by a rising pound. As a result, any improvement in terms of trade may be partially offset by the currency move. Inflation, which has been boosted by the fall in currency, could be reduced. Overall, investments that have done well since the Brexit vote may come under pressure unless global growth can offset these effects.

So in this hypothetical scenario, what investments would we expect to do well? Europe exports more to the UK than it imports. Meaning that open trade with the UK could give a boost to European stocks that export to the UK. However, any rise in the pound could offset this for sterling based investors. Buying European stocks with a currency hedge may be the best bet in this scenario. With Irish intransigence and hard line Brexiteers reluctant to pay the bill we remain a long way from such a deal. I suspect that even if a deal to get to the next stage is done this week, we will probably have to wait until 2019 for a final agreement and to see if, after all, money can buy you love.

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