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May 10, 2010

Expert Election Analysis

By Spear's

The top family offices, wealth managers and accountants have sent us their reaction to the General Election result: what do they think a hung parliament or a coalition government will mean for HNWs and the markets?

Jonathan Bell, Chief Investment Officer, Stanhope Capital

The failure of the UK to elect a single party government has weakened sterling. Although we would have preferred a single party to a coalition the outcome of the election is unlikely to have more than a short lived impact on markets. Longer term the UK faces the same fiscal issues as many other European countries with high deficits and will need to produce policies aimed at reducing the scale of the deficit. The difference between the UK and the euro region is that inflation is more likely to be part of the UK solution.

Jeremy Beckwith, CIO, Kleinwort Benson

The public have had their say, and faced with three principal choices, their answer would appear to be, ‘None of the Above’. Together, Labour and the Lib Dems have no majority. Neither do the Conservatives, aided by their traditional Irish allies. This is a very messy and unfortunate result for financial markets.

If the Conservatives wish to hold power they would have to find some accommodation with the Lib Dems, at least to support a package of measures for a first Queen’s Speech. They would not be prepared to offer a referendum on electoral reform, so a powerful alternative would need to be offered to the Lib Dems. It should be clear to all involved though that at the first opportunity the Conservatives would look to hold another election – which only they could afford – to deliver a majority, so this does not look like a stable solution. It would almost certainly cramp their ability to reduce the deficit quickly.

As sitting Prime Minister, it is Gordon Brown who should have the first attempt at establishing a majority Government, but Nick Clegg has pre-empted that by saying he would talk to the Conservatives first. If Labour enter in to a formal coalition with the Lib Dems, it is likely that part of the deal would be two or three Cabinet posts – Vince Cable still has a shot at being Chancellor – and a promise of a referendum on Proportional Representation for future elections, within a short period of time. Some carrots dangled in front of the Scottish and Welsh Nationalists in the form of promised protection against spending cuts would probably ensure their support, and in a crisis Cable could rely on support from the Green MP and the SDLP MP. Thus, a left-of-centre majority could be achieved, but the bargaining power of the small parties would massively complicate the ability to cut government spending in a meaningful way.

In this scenario, it is likely that Gordon Brown would offer to step down – at some convenient point. He does not strike me as the sort of leader who would enjoy accommodating so many different interest groups and the Lib Dems would almost certainly demand a new PM. This is a complicated but plausible scenario, and would not be welcomed by the gilt and foreign exchange markets.

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The Lib Dems are potentially caught between a rock and a hard place. The first solution could easily be characterised as a ‘Club of Losers’, desperately doing deals in order to hang on to power at any cost. If the markets rebelled at the slow pace of deficit reduction it could put back the idea of three party politics and coalitions for a long time to come. Equally they have little bargaining power, they have to appear to ready to deal and the Conservatives may not need to offer them very much, so that they are a very junior partner in any alliance to be discarded as soon as is convenient.

A common feature of the campaigns of all three major political parties was the total lack of transparency with regards to sharing with the public the true state of the public finances, and clarifying what measures will really need to be taken to put them right. Indeed, if one was only to go by the fiscal tightening measures actually detailed in any of the manifestos, then by the time of the next General Election, Britain would have approximately the same deficit and debt position as Greece.

This has been the ‘elephant in the room’ throughout the campaign, and the politicians resolutely refused to turn around and look at it. This could be an issue because there is no mandate from the election to take the painful action that will be required. At its simplest, the current level of public spending was envisaged for an economy that was at least 10% larger than it is today. This ‘structural deficit’ is thus of the order of £70bn. The rest of the deficit can be characterised as ‘cyclical’ and can be expected to reduce naturally as growth returns to the economy – the problem being that the very act of reducing the structural deficit (which could be achieved for example by raising the basic rate of income tax from 20% to 30% and by raising VAT from 17.5% to 24%) is likely to reduce economic growth and so make the cyclical deficit much worse.

A new Prime Minister can be expected to come out quite quickly with news that the public finances are in a much worse condition than has been previously admitted – this can be painlessly achieved by adjusting the future expected economic growth rates, and blaming Gordon Brown for this terrible inheritance.

The financial markets will not be too surprised, but it is now very important, following the Greek crisis and its contagious effects on markets in Portugal, Ireland and Spain, that there is a seriousness of intent and a credibly detailed plan to deal with the deficit brought forward fairly quickly. The ratings agencies have previously indicated that they have been holding off a more negative assessment of the UK’s credit rating pending the election and any new government’s plans.

Ronnie Ludwig, Partner, Saffery Champness

The make-up of the next UK government remains uncertain and a range of options is open, each with different implications for UK taxpayers.

A new government led by the Conservatives is likely to be more sympathetic towards the wealthy as they recognise the importance of wealth creators in stimulating the economy, creating jobs and ultimately redistributing wealth across society. Under a Tory government, we can expect a reversal of the top 50% rate of tax at some point in the future with possibly a rise in VAT to offset the losses to the Exchequer. Given the Conservatives’ stated commitment to reducing public debt, we can also expect cuts in public spending.

Another possible scenario is a Tory-Liberal coalition and the fiscal landscape for the wealthy is likely to be very different from what it would be under a Conservative-led government. The Liberal Democrats are more interested in increasing the threshold at which tax becomes payable than in reversing the tax hikes for high earners. We could see the tax-free personal allowance increase to £10,000 as proposed in the Liberal Democrats’ manifesto, and the 50% tax rate is likely to remain in place. In fact, it is possible that the threshold at which an individual starts paying tax at 50% could be reduced from the current £150,000 to, perhaps, £100,000.

Under a Labour-Liberal coalition, public spending is likely to remain at its current levels and again, the Liberal Democrats can be expected to press for an increase in the tax-free personal allowance to £10,000. High earners would probably continue to bear the brunt of tax hikes and we might see an intermediary income tax rate, perhaps 45% applied to incomes between £100,000 and £150,000.

With the government under pressure to maintain public spending levels whilst managing Britain’s public debt, VAT and capital gains tax rates may be increased. Liberal Democrats have outlined plans to realign capital gains tax rates with an individual’s top rate of income tax and this cannot be ruled out under Labour-Liberal government.

Charles MacKinnon, CIO, Thurleigh Investment Managers

We have been, and continue to be significantly underweight UK equities and Sterling in our portfolios, but we are not selling any more at current levels (£/$ 1.47) despite thinking it could retest recent lows of (£/$1.37).

We do not own any UK Government bonds, and do not anticipate buying any in the near term. However, the continued blow up on the continent and weakness of the Euro is starting to create opportunity in European equities, as many corporate entities are in quite good shape and the weak Euro will make their life much easier.

It is not yet time to significantly add to equity positions anywhere, as the events yesterday in the USA show that there is still only a very fragile calm in markets.

Thurleigh’s preferred assets continue to be emerging market bonds and currencies and commodities, and indexes of very large-cap global and emerging market equities.

Liam Bailey, Head of Residential Research, Knight Frank

The housing market saw a marked slowdown in activity in the run up to the election, mortgage approvals fell 30,000 between January and March compared to the previous three months, and sales volumes across the UK have declined.

Knight Frank’s research in London confirms that buyers and prospective vendors have been increasingly likely to sit and wait for some post-election clarity. Unfortunately the morning after the election we still do not have that clarity.

Irrespective of the composition of the next Government, the future outlook for the UK’s housing market will be determined by a single policy issue – the approach taken to tackling public sector debt.

Scenario 1: A stable Conservative-led Government

It seems possible that if Gordon Brown, who as the incumbent prime minister has the first chance to form a coalition government, fails to gain a sufficiently strong mandate the Conservatives will try to govern alongside Northern Ireland’s Unionist parties. If David Cameron is able to create a sustainable coalition, he is likely to be much more radical in his attempt to cut the deficit than he alluded to during the campaign. The Conservatives are likely to try to reduce the deficit to below 4% of GDP within five years, and potentially even below 3%.

Spending cuts will be favoured over tax rises, and these cuts will need to be large. The result will be that the pound will rise in the short term, and bond yields will fall as investors become more confident in the UK’s wiliness to address the fiscal crisis. Rising unemployment from lost public sector jobs, and lower wages from pay freezes and even cuts will put some downward pressure on the housing market. So too will negative impact of the wave of strikes which will undoubtedly accompany this process.

These negative trends will, however, be offset by lower interest rates and mortgage rates which are likely to follow declining bond yields. Increased investment interest in property, and other assets, will follow the lower cost of financing. These trends will mean that while we still expect house prices in the UK to end the year down slightly, these falls ought to be modest. The trends also point to slow growth in sales volumes over the year, reversing the pre-election slowdown.

Scenario 2: An unstable coalition

It seems from the current results that a Labour/Lib-Dem coalition would still lack an overall majority, and there is still a real prospect of a messy and unpredictable coalition government, with a real question mark over its ability to push through tough legislation on government debt.

The initial reaction from the financial markets over night gives some indication of the impact of this more uncertain outcome – with the pound falling back and gilt yields rising.

If these trends continue there will be a growing risk of higher inflation, due to the weaker pound pushing up import prices, and rising interest rates on the back of higher gilt yields. Both trends would create pressure for higher interest and mortgage rates.

Under this scenario the risk for the housing market would be a greater number of mortgage arrears and even defaults with higher mortgage costs, and also much slower return of growth to mortgage lending over time.

Confident predictions

If the above comments are unavoidably hedged with uncertainty, we can at least say with more confidence that the current trend towards a two-tier market, split between an active mid and upper end and a more depressed lower end, will continue.

Mortgage availability will remain tight over the next two years, especially as the banks begin to repay government loans extended through the Special Liquidity Scheme at the height of the credit crunch. The banks will also continue to ration mortgages using sharply differentiated lending rates depending on deposit levels.

With the Lib-Dems unable to capitalise on their apparent surge in popularity during the election campaign, we can also be fairly confident that their proposed “Mansion Tax” and VAT on new-build housing will not see the light of day – much to the relief of estate agents and house-builders.

It will not be at the top of the list of the next government, but the days of the Home Information Pack certainly seem numbered, to the benefit of the market.

Despite all of the uncertainty we find ourselves with the days after the election, we stand by our current forecast that house prices in the UK will end the year 3% lower when compared with the start of the year, and that prices in the central London prime market will rise by 3%.

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