Unless Gordon Brown's grim determination to hold onto power involves a coup d'etat, then the British public can be certain that – by June at the very latest – 2010 will see a general election in the UK. And, with a tired Labour party trailing far behind in the polls, and led by a man who seems to court unpopularity and gives the impression of being fresh out of new ideas, then change appears to be on the cards. Indeed, that change could even turn out to be as complete as that which swept Labour into power way back in 1997.
If that proves to be correct, and David Cameron and his reinvented PR-friendly new Conservatives are handed the keys to Number 10, then some dramatic and sudden changes can be expected in economic policy, and in the approach to public spending and taxation. These policy shifts could have big implications for investors.
Indeed, at a speech to the CBI in November, Mr Cameron's main economic policy priority finally began to emerge – and it clearly centres around tackling the swingeing levels of public borrowing. He told the conference that "dealing with this deficit is not an alternative to economic growth - the two go hand in hand." But dealing credibly with the deficit can only mean chunky cuts to public spending accompanied, quite possibly, by hefty tax rises. Certainly, that may be a sure route back to fiscal prudence – at least at a faster pace than Labour’s plans are likely to allow - but it will also have major implications for the rate at which the economy recovers and the scale of the provision of public services.
At its most basic level, cutting deep into public spending will effectively cancel the existing Keynesian-style economic stimulus programme. It's reasonable to assume, then, that this will hamper economic recovery - even though that recovery may turn out to be built on firmer foundations as a result once it finally gets underway. The problem for investors is that the bull market that has gripped equities since the spring is largely founded on an expectation of impending economic recovery. Take that expectation away, or at last delay matters, and the bull market might stumble for a while - bad news for investors in cyclical sectors that have performed so buoyantly since March. So, should the Tories find themselves back at the helm, then hedging one's bets with a decent spread of defensives sectors might prove wise - such as utilities, telecom providers, biotech players and even tobacco companies.
Beyond that general effect, cuts in public spending will hit some sectors more directly than others. Prospects for companies with state contracts in construction, support services, and healthcare-related services might start to look uncertain. And, should taxes rise dramatically, then that’s going to hit consumers' ability to spend - so retailers and leisure-related sectors could struggle. It's unlikely to help the housing market, either, with already hard-pressed borrowers potentially finding mortgages even harder to manage. Unemployment could rise further without such a huge level of sate support for the economy – which might also spell bad news for consumer spending. Although that effort to tackle the deficit might prove better news for sterling, which in turn could prove to be bad news for the UK's exporters.
Not that the future will be dramatically brighter in the unlikely event that Gordon Brown hangs onto power. Certainly, his instincts are very different from Mr Cameron's - he told the same CBI conference in November that "our strategy for growth is not at the expense of necessary deficit reduction - it is absolutely central to that objective". Essentially, Mr Brown believes that growth will cut the deficit, while Mr Cameron thinks that sustainable growth is only possible with a reduced deficit. So Labour's re-election is unlikely to see a sudden halt to public spending.
The trouble is that recovery is taking longer than anticipated - UK economic output shrunk by 0.4 per cent in the third quarter when a modest return to growth had been largely forecast. And the state of public finances is now so dire that country simply can't practically afford to keep Labour's stimulus package going for much longer. So the pressure to cut back in the post-election period could start to become overwhelming - regardless of whether recovery is entrenched or not. Oddly then, and while Labour won't like it, it could to be forced to cut public spending and raise taxes - essentially the same outcome as with a Tory government. And, with so much cash having been pumped into the economy, especially through the Bank of England's quantitative easing scheme, then efforts to head-off inflation may also appear on the agenda in the post-election world. That could potentially see the base rate begin to rise from the current sub-inflationary 0.5 per cent level – another potential break on recovery.
The differences in the tightening under Labour are likely, then, to turn out to be ones of timing and degree. With that scenario, the bull market could still stumble, even if it takes longer to do so. And with the unavoidability of public spending cuts, then the same cyclical sectors identified above could still struggle - even if spending isn’t cut to the same degree and as quickly as under a Tory government. So it would still make sense to seek exposure to defensive sectors. In summary, the policy options are heavily constrained by the reality of the UK's grim economic conditions. And apparently simple choice between more public spending - with Labour - or sound finances - with the Tories - are, in reality, largely illusory.
