Are UK risk assets pricing in the possibility of political realignment?

Thu 15 Aug 2019

UK assets continue to trade at a discount to the rest of the world, however, with so much political uncertainty facing the UK this may be justified.

Boris Johnson’s new special adviser Dominic Cummings is by all means unorthodox. Mr. Cummings was the Campaign Director for Vote Leave in 2016, and used machine learning and data science techniques to develop targeted Facebook ads; an innovative, but highly controversial move that has changed political campaigning forever ( the same data driven strategy was adopted by the Trump team in 2016). His blog provides a great insight into his strategic decision making framework, and here one can find numerous essay’s, often thousands of words long, detailing how the government could be altered and improved using techniques borrowed from systems management, statistics and the success of Berkshire Hathaway ( the investment company owned by Warren Buffet).

In blog posts that date before the 2016 EU referendum, Mr. Cummings noted that one need not convince the British public that huge action is necessary on the topic of immigration, but instead he suggests that the argument should be framed as “ If you are happy with the status quo, vote Remain,  otherwise, vote Leave” Today, the new government which he advises is shaping the Brexit narrative in a similar manner. From “Brexit or Second Referendum” to “Deal or No-deal”, Brexit is presented as a “fait accompli”. Mr. Cummings has also indicated that the government would be willing to challenge constitutional precedent and not call for a general election even after a no-confidence vote. Therein lies the rub. The new government fully understands that people are tired of Brexit –and maybe politics altogether. The opportunity is thus open for what is known as a “political realignment”: the complete and quick shift of the electorate into a new political formation. Four European countries have already experienced this. In France, Macron’s “En Marche!” swept politics two years ago. In Italy, Greece and Hungary the Five Star Movement, Syriza and Fidesz are relative political start-ups, achieving government status in record-time. The common element? Disappointment with the political status quo, a sense of some lost past greatness and economic malaise.

Failure to deliver Brexit could see a political party unlike anything we have seen before. A party maybe not tied to traditionalism, operating like a modern technology company using AI and machine learning algorithms to achieve its goals. Much like a start-up. Mr. Cummings states on his blog that he has “never been part of a political party”. So it stands to reason that the plan he’s working on could be disruptive to the status quo. Another “Start-Up” Party is therefore entirely possible.

UK equities continue to trade at lower valuations. The FTSE 100 trades at a discount of around 20% to the MSCI World. European stocks trade a similar discount, while US stocks trade above their short term average valuations. Though the economic outlook for Europe is not great (German manufacturing PMIs are at multi-year lows and industrial production continues to fall), the European economy is likely to be more robust than the UK’s in the event of a no-deal Brexit (if the BoE’s forecasts are anything to go by!) And, with so much uncertainty presented by Boris Johnson and Dominic Cummings, in our view it challenging to hold UK equities over overseas equities at present. There are simply to many unknowns and we don’t believe that political realignment can actually ever be priced in, no matter how large the probability.

Instead, we prefer US Equities which are generating ROEs high enough to justify their above average valuations and where the economic environment is still relatively stable.

Daniel Gorringe, Investment Analyst