How will the markets react to a hung parliament?

Overseas assets might be a safe bet now, says John Hildebrand of Rensburg Sheppards

If the Queen is being "primed for a hung parliament", as the Sunday Times recently suggested, markets will also be trying to factor in the ramifications of an unclear result in the forthcoming UK elections.

Markets like certainty and have little experience of hung parliaments in the UK. So what might happen, and what impact could it have?

To answer the first question, look at what has happened in the UK before. In 1974, the Tories under Edward Heath won the popular vote but got fewer seats than Labour and failed to make a pact with the Liberals. This led to a minority Labour government and a further election in October. This was a volatile period for UK equities, which fell by 18 per cent in the month after the first election.

In the election of 1929, Ramsay MacDonald won the most seats but failed to get an overall majority. This government survived until October 1931, when a coalition was elected. This was during the depression, so the effect of the hung parliament is hard to measure, but the figures from this time also suggest markets are unlikely to have an easy ride.

But minority governments have operated in both Sweden and Canada for most of the past 40 years, with seemingly little effect on their national stock exchanges.

Hung parliaments have become a feature of the UK's regional assemblies, with elections in Scotland and Wales in 2007 giving no party overall control. In Scotland, the Scottish National Party has survived as a minority government, and in Wales the Welsh Assembly is controlled by a Labour-Plaid Cymru alliance.

Overall, though, markets dislike weak governments and would sell sterling-based assets if the government was thought to lack the strength to make the cuts necessary to bring the budget deficit back under control. This would further weaken gilts and sterling, but is not likely to be as big a problem for equities as it was in 1974. A much higher percentage of the earnings of FTSE 100 companies is now generated overseas than it was in that year.

Given the uncertainty in the markets, our advice would be to have biases towards overseas assets and companies likely to benefit from sterling weakness. But market weakness, based on the prospects of a minority government, could create a buying opportunity if a stable majority coalition is formed or the largest party operates successfully as a minority government. Opinion polls have some margin of error and a lot could happen between now and the election. An overall majority for the Conservatives is still a likely scenario.

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