Political power plays & market reactions

In the 21st episode of Connected Investor, Joe Lynam and Julian Bishop navigate the choppy waters of national politics and their ripple effects through global markets. With the recent political changes in the UK and the much-anticipated US presidential election, what can investors expect from the stock market?

This is a marketing communication. Please refer to the key information document or KID before making any final investment decisions. Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested. Past performance does not predict future returns. The mention of any particular security or strategy should not be considered as a recommendation. For further information on the Brunner Trust please go to www.brunner.co.uk.

JL: Hello and welcome to the 21st and latest instalment of Connected Investor, the podcast from the Brunner Investment Trust. I'm Joe Lynam, the BBC World Service presenter, and News Talk Business editor, and in this podcast, we're going to discuss the ramifications of a major change in government in the UK and its implications on stocks and bonds, as well as what impact the US presidential elections could have on the markets this autumn, and what it would mean, of course, to investors in the Brunner fund. I'm joined by the co-lead Portfolio Manager of the Brunner Investment Trust, Julian Bishop, who is the wise man. Hello, Julian.  

JB: Hello, Joe.

JL: So, we have a few weeks under our belt, under a new UK government. they have pretty quickly set out their stall. What does it mean? And what should we expect from, the new Labour administration?

JB: Well, the first thing I points out is that by international standards, I think the UK, for the first time looks to have its house in order. So, you know, in the US, there's a pretty uncertain political situation. In France obviously, you know, far right and far left. So, the UK's political risk as a whole is actually looking pretty limited. With regard to Keir Starmer's election, I mean, the first thing to mention is that this was very much expected, and markets tend to move and respond to new information. So, the overall impacts on the Footsie 100, for example, has been very, very limited. And I think, Starmer has persuaded the city that he's a pretty pragmatic centrist, which I think markets generally quite like. I think this would be a very different story if this was Jeremy Corbyn who had just been elected.

JL: That would be less boring, alright.

JB: That would be definitely less boring. I think this is seen as business as usual, but with, perhaps greater stability to those in charge. So, he's got a very, very large, mandate. The Labour Party seems like it's not squabbling in the same way the Conservative Party was. So hopefully there's more stability amongst the senior people in government roles like the chancellor etc.

JL: Now it's the first female chancellor, and she has gone out of her way before being, given the new role of kind of courting business, hasn't she?

JB: She has, absolutely. And I think that's been part of Starmer’s overall approach to the city. They want to show the world and show the electorate, persuade financial markets that their reasonably moderate, they're not going to do anything foolish. And I think a good sort of reminder to them and to all governments really was what happened during the Truss Kwarteng budget, which was, you know, unfunded tax cuts. The bond markets responded appropriately to those, and they said no. And so, you have to think about the bond market that like the sort of banker, if you like. So, they know that they operate within a certain straitjacket, which limits what they can do on both the tax front and on the expenditure front. So, I think overall, people have been persuaded that this government will be quite centrist. They want to appeal to the middle ground and therefore nothing reckless should be expected. Another thing to point out is that, you know, the UK market, the UK stock market actually has fairly little to do with the UK economy. So, I forget the exact number, but it's over 80% of revenues, I believe, Footsie 100 companies actually come from overseas. So, you could argue that what happens in China, the US and in Europe is actually as, if not more important as to what actually happens in in the UK economy. So, for example, if the Labour government was to increase corporation tax rates, that would only apply to profits that are earned in the UK, which is a reasonably small part of overall Footsie 100 earnings. And then just finally as a reminder that if there was, you know, a worst-case scenario, some kind of crisis, if the pound falls, that's actually good for Footsie profits because of the translation effect, the value of profits earned overseas and dollars will be higher in pound terms. So, we saw that after Brexit when the pound took a big step down and overseas profits and started sterling rocketed. So, you know for me not a huge piece of news in terms of its relevance to financial markets. I think Starmer and this Labour government have worked hard to get a reputation as being pretty pragmatic, prudent, centrist, and I would expect them to govern in that way.

JL: They have promised to beef up spending when it comes to renewable energy, and I wonder whether that could have a similar impact on the UK economy that the Inflation Reduction Act has had in the United States, i.e. a lot of state support, and now the UK is no longer in the European Union, is no longer subject to state aid rules so it can kind of do that.

JB: It can do that. But it would have to be costed, it would have to be funded. I mean, one of the very immediate policy decisions they took was, to remove the ban on onshore wind farm development. And so, it's probable that we will see a sort of burst of activity there. So far, there hasn't been anything equivalent to the US Inflation Reduction Act, which for those who don't know, was a sort of huge program of investments around renewables, and around reshoring of things like semiconductors from Asia to the US. So, it's very stimulative. I think by and large, when that began, the US was in a slightly better financial state than the UK. So, the existing budget deficits weren't quite as high as they are in the UK. And then I mean, we can discuss this later, but the US does benefit from this thing which economists term the exorbitant privilege, which is this idea that unlike the UK government, that the US government can basically do what it wants, it can spend what it wants, and people will always fund the country because the US dollar is the world's reserve currency, so they can probably get a bit away with more government stimulus than the UK economy can.

JL: Yeah, no, we're going to come to the US in a moment. Which sectors do you think will benefit though? I mean, planning and the relaxation of something in the planning rules appears to be important for this new government.

JB: Yes. So, the Labour government, I think rightly has made, a big deal about just housing affordability. And they're looking at supply side solutions to that, i.e. removing the barriers to building new homes, increasing supply and therefore getting prices down that way. So, I think that is probably beneficial for businesses like home builders, for building supplies companies, I mean, we have a couple of investments in that space, which we would expect to benefit from this. So, this is a good example, perhaps, of where they can use policy to improve economic growth. You know, we know that there's more demand for housing in the UK, that there's a real shortage, but that just hasn't been the building. The building is, you know, really good economic activity its very labour intensive. It creates good jobs. So here by relaxing, planning standards, they can kill two birds with one stone. We invest in a company called Redrow, which is a sort of smaller UK home builder, that's actually been acquired or is in the process of being acquired by Barratt Developments, which is a much bigger home builder, but we'll probably cling on to Barratt Developments once the deal goes through, it's a space we like.

JL: Now on the other side of the Atlantic is, of course, the American election we’re a few months before that happens. But it has been incredible thus far. The amount of turbulence that we've already seen in the last few weeks. In that sense, Joe Biden is stepping down. He's no longer standing. Donald Trump has survived an assassination attempt and Kamala Harris has been quasi anointed.

JB: Yeah. It seems I mean, yeah. So, assassination attempts, Biden, I think stepping down into, you know, in the face of mounting evidence, he just wouldn't win. And the Democrats have similarly gone with the obvious choice, which is Kamala Harris is the current VP of the US. Probably the easiest person to anoint at this late stage. Seems like the Democratic Party is coalescing around her, which I think is sensible. I think we can all appreciate in the UK, the sort of squabbling, argumentative party is pretty off-putting for the electorate. So, I think they’re doing the sensible thing there. She's not the ideal candidate, but I think she has reasonably broad appeal and I think the Democrats have a greater chance of winning with her, as a nominee rather than Biden. But the current betting odds show Trump as the favourite still all be it not by quite as large margins may have been the case before Biden stepped down. When Trump was last elected, he put in place a group of very stimulative policies. So, one of the most meaningful in stock market terms was these huge cuts in the US corporation tax rates. So, I remember when I started in this business, I was always, you know, slightly surprised. I used to think of you know, as the US is the sort of reasonably low tax economy, but actually corporation tax, the tax on profits in the US used to be in the high 30s, percent. Competitors of 20 or 25% in Europe. And he took a knife to that and cut tax rates on profits in the US down to the low to mid 20s. So that was a big windfall for corporate profitability in the net line. But one of the implications of that was a pretty large budget deficit. And then, you know, as we just mentioned, Biden has continued on this path of stimulus with the Inflation Reduction Act. And then that result is, you know, just very consistent budget deficits, which is quite unusual when you don't have a recession. That was partially explained by Covid as well. There was a lot of stimulus then but basically the US government has been spending beyond its means for quite a few years now. And because of their exorbitant privilege, they've been able to get away with that. But that's just a convention. It's not a hard and fast rule. You know, at the end of the day, the US government needs to persuade overseas investors that, you know, US treasuries are worth, what they say they are. And that depends on not having too much inflation. So, you do need to be very, very careful I would caution.

JL: And that depends on China who own so many U.S government bonds. If they decided to dump those onto the market that could be disastrous.

JB: Yeah. I mean we’d be in reasonably unknown territory there. But what the U.S. government needs to do is persuade the buyers of bonds that the dollar is safe and that there won't be too much inflation that erodes the value of its financial assets. So, you know, fiscal prudence is needed in the US as it is in the UK. So, I'm not really sure that means Trump would be able to do if he did get into power. I suspect repeating his previous behaviour just simply wouldn't be tolerated by the bond market, so it'll be interesting to see how that pans out.

JL: Kamala Harris is from California, and that's where all the tech bros usually live. Is there a chance that she would be pro technology or, is it going to be bad for the miners and the oil explorers?

JB: I think there’s a view that's, you know, the Democrats, will regulate a little bit more the Republicans sort of free market people they don't like to regulate. And there are certain sectors where that does have an impact. I think for most businesses who’s in charge doesn't matter that much. I think for certain sectors, policy does matter. So, you know, there’s this slightly cartoonish, but you could say that the Democrats will work harder to phase out oil. You know, they'll try accelerate electrification of vehicles, etc. So, actually, it might be good for, good for Tesla, you know, Trump might delay that. So, you know, reduce subsidies for renewable energy. It's probably good for, you know, the Detroit three, General Motors, Ford who sell a lot of very large pick-up trucks, to middle America. And things like health care, you know, the U.S. health care system, there are some government sponsored programs, but it's largely a free market system. It’s pretty inefficient, to be fair. There's probably a view that the Democrats would try and centralise the procurements of pharmaceutical drugs, for example, which would probably be to the detriment of the big pharmaceutical companies, probably a view that the Republicans would be a bit more hands off and allow the free market solutions to continue, you know, etc. So, there are some sectors where things could vary depending on the outcome of the election, but I wouldn't probably exaggerate those. In technology itself, I don't know, it's very hard to say. I think by and large those companies are lower into their own, no one so far has really displayed much appetite to regulate them. And I don't really see the Democrats doing anything that would adversely impact one of those great American success stories, which is the technology sector.

JL: Well, that's a pretty good place to pause and thank Julian Bishop, the portfolio co-lead of the Brunner Investment Trust. That's all the time we have for this episode of Connected Investor. Make sure you're subscribed to the Connected Investor wherever you get your podcast, so you don't have to go hunting for it next time. Thank you all for listening. We value your views and we're keen to know what you think. So do get in touch. You can contact us via the website at Brunner.co.uk, if you could also leave a review and give us a rating wherever you get your podcast from, that would be great. And so, we can learn for next time. So, from me, Joe Lynam and Julian Bishop, tata for now.