SocGen recommends dumping UK equities before general elections
French investment bank Societe Generale has recommended selling UK equities before May’s general elections as the country’s assets are likely to have a tough time in the weeks leading up to the event, with the outcome too close to call.
Polls currently put the Labour Party slightly ahead of the Conservative Party, but with no absolute majority, hence the risk of a hung parliament is high, said SocGen, suggesting that the formation of a coalition looks the most likely scenario. “The result of this election could prove more disturbing for markets than in 2010,” the bank said.
SocGen believes the uncertainty and risks are also bigger this time around because of the Conservative promise to hold a referendum on UK membership of the European Union if it wins the general election, otherwise known as a ‘Brexit’.
“A clear electoral mandate to go ahead with a referendum would be a risk for UK assets. SocGen economists put the probability of a ‘Brexit’ referendum at 25%,” the bank said, adding that an exit from the EU would be damaging to the UK economy, cutting growth by 0.5% per annum.
As such, the bank thinks the political uncertainties coupled with large economic imbalances leave UK assets vulnerable.
“There is a lot at stake in this election as the UK economy is burdened by significant imbalances. The twin budget and current account deficits are important issues that need to be dealt with, as well as declining productivity growth. A weak government would most likely be unable to deliver the necessary policies. In this context, UK assets are vulnerable,” analysts wrote.
Against this backdrop, SocGen recommends switching out of UK equities.
Despite the FTSE 100 index now at all-time highs, the leading benchmark is not a favourite for SocGen.
“We remain shy of UK equities. Our analysis of the potential impact of the general election on the FTSE 100 lends weight to our preference for Eurozone markets, now backed by an aggressive ECB and structural reforms. Up to the election, the spectre of a Brexit vote should also continue to weigh on the FTSE 100."
For sterling, SocGen recommends re-setting long-term strategic short positions in GBP/USD close to the election at a level close to 1.60. “We favour trading any post-election sterling strength through the interest rate market rather than the FX market. Short Gilts versus Bunds is a better trade in our view than being short EUR/GBP at these levels,” the analysts added.
As a result of sterling’s fall, international investors will turn more cautious on UK assets and would weigh on both equities and bonds, said SocGen, noting that UK Gilts yields could be 30 to 35 basis points higher at the end of 2015 in a ‘Brexit’ scenario than in the coalition scenarios while the UK equity market could drop by more than 20%.