What impact would a Tory election victory have on the markets?
When Theresa May called an unexpected early election the pound rallied sharply. She had a lead of over twenty points in the opinion polls and was projected to get a majority of over 100 seats in parliament. Since then, opinion polls have reduced the lead somewhat however we do still expect the Tories to have an increased majority in Parliament. Calling an election at this time means that May will not be up against electoral pressures as we approach the end of the negotiating process and, as a result, should be able to take a more gradual approach to Brexit when it comes. It was also felt that a large majority would strengthen her negotiating position. In practice, the UK election may have little impact on the outcome of the Brexit negotiations. While Theresa May may have better support in Parliament, the other 27 countries of the EU still have the same agenda.
Markets react to unexpected events and a Tory victory would be expected so is unlikely to have a big impact. A 100 seat majority could see a small move upwards in the pound and if by any chance it turns out to only be a narrow victory then we could see the reversal of the recent recovery in sterling. When it comes to equity markets a large Tory victory could be welcome news for some domestic stocks but the main indices are made up of stocks with large proportion of overseas earnings. Consequently, a rise in sterling, all other things being equal, will have a negative impact on the FTSE 100 index. This means that a large majority could see the headline index fall but some individual domestically orientated stocks rally.
In the long run we expect that the pound and equity markets will react more to changes in the global economy and the progress of Brexit negotiations than to the UK domestic election.
Do periods of low volatility imply high volatility is imminent?
In short, not necessarily. Some may argue that low volatility is a sign of markets getting complacent and that this leads inevitably to sharp corrections. However, in the past volatility has remained low for extended periods. Extreme high volatility can be a sign of a capitulation trade, is often short–lived and can be an indication of a market reaching a bottom. Volatility has been declining and is relatively low but this may be more a symptom of what has gone on rather than an indication of what maybe about to occur.
Some people have suggested buying volatility as a way of protecting equity portfolios. This may work as a short term trade but there is a very high cost in running these strategies long term and, as such, our in-house view does not recommend such trades at this time.
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