The election effect

Prior to Gordon Brown's defeat in 2010, the late stock market historian David Schwartz found that in every election year since 1945, the average increase in the London exchange was just 2.2 per cent - compared with a 9.8 per cent annual average return for the period as a whole. In 2010, in the initial fog of coalition formation, markets were in turmoil: the FTSE 100 fell 10.5 per cent in the first week of May, its sharpest decline in 14 months, as the pound plunged 4.5¢ against the dollar. Uncertainty was not good news for markets (nor indeed was a backdrop dominated by Eurozone chaos and a sovereign debt crisis). In the end, however, the main market bucked the historic trend and actually did rather well in 2010, with the FTSE 100 rising 13.5 per cent and the FTSE 250 growing 28 per cent.

Five years on, and with the existential cracks in the Eurozone merely papered over with freshly printed money, the picture for the UK is quite different. Productivity is lagging and a serious worry, but on other key measures - as the Prime Minister and Chancellor will repeat ad infinitum between now and 7 May - the economy is growing and unemployment has fallen. The FTSE 100 may be an imprecise measure of the economic health of the nation, but it has certainly benefited from this, evidenced by a compound annual growth rate of 6 per cent over the life of this parliament, well ahead of increases in GDP.

Given voter fragmentation, this election will be different in another sense. Both a Labour-SNP and a Conservative-UKIP coalition have been ruled out by Ed Miliband and David Cameron respectively. The Liberal Democrat Party is still the most obvious candidate for the role of kingmaker, but its expected decimation at the ballot box further diminishes the likelihood of a workable coalition. Missing this time round is the fevered sense of urgency to tackle the financial crisis - and form a government as soon as possible - that was present in 2010, leaving the distinct possibility of a hung parliament or minority government this time round. How this will translate to equity markets is moot, though Schwartz found closely fought elections lead to average declines of 15 per cent in the main market. Assume the brace position.

If the election results in parliamentary stalemate, there are few precedents for comparison. The most recent was February 1974, when Tory leader Ted Heath refused to leave Downing Street until it became clear he couldn't form a working majority to supplant Labour's newly elected minority government. Political paralysis continued until October, as instability in Harold Wilson's Labour government led to a second general election, which Labour won. During this period the stock market was hammered, but less for domestic political wrangling than the global economic meltdown sparked by the dollar devaluation and 1973 oil crisis, and upheaval in the UK banking and property sectors.

As the IC's Chris Dillow has shown, recent election campaigns tend to have fairly benign effects on markets, and do not usually lead to greater-than-average volatility. Stewart Robertson, a senior economist at Aviva Investors, is not overly concerned even in the event of a choppy run-in. "While financial markets may become increasingly volatile ahead of the election, the budget does little to alter our upbeat assessment of the prospects for the economy," he says. "While the prospect of a hike in US rates this summer tempers our enthusiasm for equities and other risk assets, once the uncertainty around the general election subsides, prospects for UK stocks are encouraging."

And for all that is at stake, markets have been given a far clearer forecast for the next parliament: there will almost certainly be further cuts to public services and continued low interest rates. Certainly, the divergence in fiscal policy between UKIP, the Liberal Democrats and the Conservatives - currently third, fourth and first in the polls - is not enormous. Labour is also committed to austerity, albeit at a slower rate, meaning financial markets already have a decent range when pricing the cost of government borrowing. This will have already de-risked share prices to a degree.

Savers' are a regularly courted tribe of voters, but in political currency, 'investor' is less populist. Indeed, the Liberal Democrats' plan to increase the capital gains tax paid on shares from 28 per cent to 35 per cent will win little support among the group. So there is no expectation of concessions for small shareholders. Instead we take a look at several sectors whose fortunes are inextricably tied to the political direction the UK will take in May, and what this might mean for investors.

Financial services

Whatever the make-up of the government formed after May's election, there is one certainty: the major UK banks will remain a political punch bag. As chancellor George Osborne put it in the March Budget: "The banks got support going into the crisis - now they must support the whole country as we recover from the crisis." The anticipated announcement of an increased banking levy did not put an immediate dent in bank shares, but for banks such as Barclays (BARC) with greater exposure to the UK, sentiment has been hit. Broker Investec downgraded the stock from buy to hold, arguing that the increased levy pushed back the 'normalisation' of its return on equity to 2018.

An overriding issue for the government in the banking sector is how to dispose effectively of its stakes in Royal Bank of Scotland (RBS) and Lloyds Banking (LLOY). The latter is proving more successful, with the government's stake in Lloyds down to 22 per cent, and Mr Osborne planning to sell another £9bn worth in the current financial year, but RBS is proving trickier, despite the chancellor's stated intention to "get rid" of the government's stake.

Much of the promise for greater intervention is coming from left-of-centre policymakers. In a signal of future Liberal Democrat policy, business secretary Vince Cable reportedly pushed during this parliament for the state-owned banks to be compelled to lend more to small businesses, but critics have warned about the impact on these businesses' ability to compete.

Labour may well pose the bigger threat to lenders' profits and pay packets post-May. Promised bonus claw-backs, a one-off tax on banker bonuses and an extended levy on payday lenders are all planned. Last year Mr Miliband talked about a reckoning for the 'big five': HSBC (HBSA), Lloyds Banking Group, Barclays, Royal Bank of Scotland and Santander (BNC). These face being broken up, with the government forcing the creation of two so-called 'challenger banks' to increase competition for the benefit of the consumer.

But analysts think this rhetoric may prove unfounded given the time and effort to separate banking operations. The expensive long-running carve-out of Williams and Glyn from RBS is not expected to be complete until the end of 2016, and these spin-offs can bring with them legacy issues. "It is easier to create new banks than to break up bigger banks," argues Adam Daniels, managing director in the financial institutions team at Lloyds Bank. Politicians will talk tough on banks, but intervention in the sector can prove costly and unpredictable. IS

Utilities

Energy bills have become one of the key election battlegrounds. Mr Miliband has promised voters a raft of reforms in the energy markets, most notably a gas and electricity price freeze until January 2017. The Labour leader also wants to abolish Ofgem and replace it with a "tough new energy watchdog". This regulator will have the power to force companies to cut their prices when there is evidence of overcharging. This could be when wholesale costs fall and markets fail to respond. Shares in British Gas owner Centrica (CNA) and SSE (SSE) initially fell 5 per cent and 6 per cent respectively in 2013 when the ideas were first mooted at the Labour Party conference.

The proposals have cast a cloud of uncertainty over the sector and created an angry backlash from the energy companies, which argue they are only the middlemen. Management at Centrica has said by exacerbating uncertainty the political debate could "impact future power, storage and upstream investment and the attractiveness of the UK energy supply business".

Nevertheless SSE initiated a domestic gas and electricity price freeze last March following Mr Miliband's proposals. Almost a year later suppliers have shaved customer bills further - British Gas by an average 5 per cent and SSE by 4.1 per cent. Analysts at Deutsche Bank said falling wholesale prices may give "headroom for the price cuts this year without hurting EPS, but long-term earnings will likely be lower with weak commodity prices". A Labour win could eat further into earnings.

On the other side of the Commons, Chancellor George Osborne has derided the policy as "phoney" and "drafted on the back of a fag packet". The Conservatives have suggested that the opposition's pledge would mean higher prices this year and in the future, predicting companies will jack up prices before the freeze, so in the short term, prices go up. What's more, Mr Osborne has suggested that energy companies will not invest in new power stations needed to satisfy the country's capacity needs, pushing up prices in the long term.

Instead, the party seems to have set its sights on controlling subsidies for renewable energy sources. Mr Cameron has said, if re-elected, the party would scrap subsidies for new onshore wind farm projects, which have yet to gain planning permission. This adds an element of uncertainty for investors in Infinis (INFI) and revenue streams for future onshore projects. During the first half of the year the group gained 39.4 per cent of its revenue from renewable obligations certificates. EP

Defence

The rise of Islamic State and growing diplomatic tensions between Russia and the West have yet to spur Britain's main political parties into outlining plans to ramp up defence spending. With the wars in Afghanistan and Iraq now very much a thing in the past and cuts being made across various other departments, it would appear that bulking up military operations isn't seen as an ideal way to capture votes ahead of this year's election.

Under the Conservative-led coalition government, Britain's defence spending has been cut by about 8 per cent in real terms, with the size of armed forces reduced by roughly one-sixth. Such vast cutbacks have hit the companies that supply the nation's military hard, including the likes of QinetiQ (QQ), BAE Systems (BA), and Ultra Electronics (ULE).

But despite various military experts warning that defence budgets can't get much lower, it's looking increasingly likely that either a Conservative or Labour win would actually result in Britain finally falling short of Nato's membership requirement. Should Mr Cameron be victorious again he's vowed to splash out 1 per cent more a year on military equipment, yet refused to promise maintaining defence spending of at least 2 per cent GDP.

The same applies to the Labour Party, whose chancellor Ed Balls also ruled out any guarantee of pegging defence to 2 per cent national income. Labour's pledge to continue cutting resources outside unprotected areas suggests that military budgets could be one of its biggest victims. In the event of another hung parliament those policies could be watered down even further. The Liberal Democrats, for example, want to share and pool resources with other EU and Nato members, while the Green Party has even discussed completely abolishing the army. Indeed, in line with its core ethos of promoting peace, the party has pledged to leave Nato, end the special relationship with the US and potentially turn army bases into nature reserves.

But defence enthusiasts will at least be glad that Nigel Farage is taking growing geopolitical tensions seriously. The UKIP leader moved beyond his anti-EU agenda to declare that his party would increase defence spending by about 39 per cent to £50bn. To date, Mr Farage is the only political leader to guarantee meeting Nato's 2 per cent requirement, despite his previous protests against UK incursions into the Middle East.

Regardless of the outcome, investors should certainly bear in mind that the three-month share performance of the aerospace and defence sector has weakened after three of the past four elections. We expect more volatility in the year ahead as military budgets are cut by a prospective new government facing growing pressures to reduce the deficit and plough more money into under-fire departments like healthcare. DL

Multinationals

To the cheer of business leaders - and as a cornerstone of its plan for economic recovery - the current administration reduced the main rate of corporation tax from the 28 per cent levy it inherited. This month it falls to 20 per cent, just in time for Mr Osborne to make the pre-election boast that Britain has "the lowest business tax of any major economy in the world". It's not a claim Labour is keen to do too much damage to, although the party has pledged to reverse this month's percentage point decline, instead opting to cut and then freeze rates for smaller businesses. Neither the Conservatives nor the Liberal Democrats have made clear their plans for keeping - or reducing - the main rate.

There will of course be much political wrangling over the macro-economic effects of tweaking the corporation tax rate, but at its heart, the main parties are not fighting over large margins. Of greater consequence for specific companies - and by extension, their shareholders - are the various parties' attitudes towards the way multinationals are taxed.

As a result of pressure from an austerity-weary public and growing international collaboration, this parliament has been marked by increased scrutiny of the tax arrangements of transnational companies, many of which have significant operations in the UK. Last month, the chancellor used the Budget to remind voters of plans for a diverted profits tax. This, he said, will raise £3.1bn from the likes of Amazon (US:AMZN), Google (US:GOOG) and other companies which engage in 'transfer pricing' - the practice of leasing out a company's intellectual property or branding from a lower-tax domiciled legal entity to one where taxation is higher. Labour has also been keen to assert itself here, with shadow Chancellor Ed Balls outlining plans for fines of up to 100 per cent on top of the tax avoided for corporations falling foul of the General Anti-Avoidance Rule.

But for all the rhetoric from British politicians, their voices will be bundled into a much broader examination of multinational taxation by the Organisation of Economic Cooperation and Development (OECD). Mr Miliband's criticism of Google's tax arrangements was rebuffed by chief executive Eric Schmidt, who told the Labour leader it was politicians' responsibility to set tax law. Indeed, the imperative to find an international solution to the issue means the biggest stick UK politicians have to wave at multinationals at this election - greater taxation - must inevitably be shared with rule-makers around the globe. AN

Property/construction

Industry bodies were quick to show their approval of the measures in the budget directed towards housing and property. But like the measures themselves the hand clapping was a largely muted affair. Perhaps the leading cosmetic gesture is the introduction of a help-to-buy ISA for first-time house buyers. With the average deposit standing at £15,000, it will take a single saver five years to reach that figure, (or half that if there are two savers) assuming that house prices stay the same - which they won't.

And making it easier for first-time buyers will simply boost demand, while the government has been painfully slow in stimulating the supply side. Most major house-builders have stressed that their rate of expansion is limited by the chronic planning system. Powers for local authorities have been increased to shape development and growth in their areas through new City Deals, enterprise zones and various other powers. But what is lacking is a national strategy: each planning authority has its own procedures which can be markedly different from a neighbouring authority.

On the retail property side, plans to revise the business rates system are long overdue. But property owners will have to be patient because it will take years before a rating system more in tune with fluctuating rental values is implemented. However, the government has announced pilot schemes that will allow Greater Manchester, Cheshire East, Peterborough and Cambridge to retain 100 per cent of the growth in business rate income - good for the local authorities but not much help for local businesses.

Infrastructure spending has long been lauded as a way of kick starting construction activity, but these plans are long in content and short on delivery. Many of the schemes that form part of the increase in spending are already in place, and finance for additional projects will face the constraints placed on public finances as a result of the government's stated objectives of reducing borrowing levels.

In short, the government has introduced plans that do little more than reach the tip of the iceberg, so current initiatives are likely to have little immediate impact on the UK property and infrastructure arena. It's also reasonable to point out that political uncertainty will act as a major constraint in the short term as investors are clearly holding back to see what colour any newly formed administration is made up of.

The best that the construction and property sector can hope for is an outright Conservative win or a repeat of the current coalition. The initial reaction to a Labour win - or coalition with the SNP or Liberal Democrats - would be a sharp mark down in share values, sponsored largely by fears of what might happen. True, a lot of election bravado is designed to catch votes rather than espouse a policy that will actually come into force. However, it does seem that there is a good chance that a mansion tax could be introduced. That would hit estate agent groups and perhaps those builders Berkeley Group (BKG) who have exposure at the higher end of the London market. There is also a possibility that Labour would introduce some form of levy on land banks, sponsored by ideas (alas, completely wrong) that builders are sitting on land and waiting for prices to rise before developing it. The truth is that sitting on land costs money, and land banks are only necessary because it takes so long to gain planning consent. On the construction side, little would change. Infrastructure projects in place would continue, but new ventures would present the same challenge for any political party - funding. JC

Outsourcing

Arguably the most high profile of the support service companies, G4S (GFS) and Serco (SRP) are still feeling the effects of the scandal surrounding prisoner- tagging contracts. Both companies incurred a plethora of impairments and charges. While G4S tipped back into the black in 2014, for Serco it has been a different story. The City of London Police may have dropped its investigation into the group for potential fraud, but its 2014 results made for dismal reading. Yet as part of the group's renewed strategy it intends to focus more on winning public sector contracts, leaving it more exposed to political sentiment.

Research by the Financial Times found more than 60 per cent of government contracts were controlled by British companies, with many going to a small number of groups like Serco, Capita (CPI) and G4S. Not everyone is happy about this. Labour's shadow work and pensions secretary last year said that if elected the party would seek to scale back the role of big outsourcers in delivering public sector contracts. She revealed that the party would do away with the current system of big, centrally-commissioned government contracts when the current set expired in 2015-16.

However with government plans to cut the public sector deficit by 11 per cent by 2018/19, and typically cost savings of 10-30 per cent up for grabs, through outsourcing, it seems more than likely that the sector will continue to play a large part in government spending. EP

The EU question

Perhaps the biggest test for UK equities in this election is not ultimately whether the winning party or parties possess the right mix of business-friendly and growth-oriented economic policy, but where they stand on the single market. In a bid to keep the euro-sceptic wolf from the door, Mr Cameron has already pledged to hold an in-out referendum on Britain's EU membership by 2017, if he is re-elected. It's a step none of the other parties has taken - with the exception of the avowedly anti-EU UKIP - either because they don't want to leave or believe (as Mr Cameron does) that Britain can renegotiate its role with Brussels without quitting the union.

Any successful Conservative showing at the election would therefore spell a prolonged period of uncertainty for markets. The prospect has certainly got the City spooked. In January the accountancy firm BDO carried out a survey of institutional investors with a combined $10 trillion under management globally, which found that 59 per cent of respondents would be discouraged from investing in UK equities if the country were likely to leave or have "a more distant relationship with" the EU. On this score, the City finds an unusual bedfellow in Labour, which has said a referendum would lead to economic uncertainty and send Britain "sleep-walking" towards to an exit from the EU.

Tom Elliott, an international investment strategist at deVere Group, adds: "A referendum will introduce considerable uncertainty into the outlook for the economy, since UKIP and other euro-sceptics are running a populist campaign that challenges the evidence of economic history of the benefits of being within a free trade area such as the EU's single market." Mr Elliott goes as far as recommending investors hedge against this uncertainty by trimming UK equities and investing in overseas equities, bonds or property, and argues that the uncertainty created by a referendum will depress capital expenditure by both UK plc looking to trade with Europe and international companies invested in the UK. Japanese carmakers Toyota (TYT) and Nissan have voiced concerns about this, as has Goldman Sachs (US:GS) president Gary Cohn, citing the passporting rules that give global banks access to Europe via London, and make the City such an attractive hub for financial services.

It is difficult to predict just how an EU exit - or a renegotiated settlement - might affect individual companies. But last year's referendum on Scottish independence serves up a couple of important lessons on this front: in the run-up to the vote last September, sentiment in the new private sector residential building collapsed on account of the uncertainty created by the poll. The share prices of RBS and Lloyds Banking Group also tumbled after a YouGov poll surprised the market by putting the 'Yes' camp marginally ahead. A similar effect is not immediately expected if the Conservatives retain power, whether or not they form a working alliance with UKIP. But in the event that Mr Cameron remains at No. 10, the risks to each company and sector posed by a Brexit would slowly emerge and send jitters across the market. The City is likely to be vociferous in its opposition to the UK separating from its largest trading partner, while smaller businesses may benefit from clearer rules. But if there's one thing markets hate, it is uncertainty. Expect equities to take some of that pain. AN