Thursday 8 June will mark the most significant general election Rathbone’s David Coombs has ever experienced throughout his investment career, according the FE Alpha Manager (pictured), who warns that a Labour win could significantly impact the UK economy and therefore domestic market movements. 
As such, he has further reduced the UK equity weightings across all four of his portfolios – positions which were already very low due to Brexit-related uncertainty.
Most of this money is being held in cash, placing the portfolios’ money market weightings at the highest levels they have ever been.
“I’m very worried. We haven’t had an election with a proposed economic strategy like this since 1983 and I wasn’t even working in finance in 1983. So, in terms of my investment career, this is the most impactful election I have seen and that’s why I’m having to take action to mitigate the potential risks,” Coombs said.
“I was already nervous on the UK anyway so I haven’t had to make huge changes, but I’ve had to take it further than I normally would do because the impact of a potential [Labour] policy being put in place.
“The probability has increased. It was always there but, two months ago, the probability of a left-wing win was very low and it’s now quite high. I suspect May will stay in power but, at the moment, I’m not willing to bet my investors’ money on that.”
Since May’s announcement of a snap election on April 18, the FTSE 100 index has risen by 6.34 per cent, with polls initially placing the prime minister on track for a runaway victory and an increase in seats in the House of Commons.
Performance of indices since April 18 2017
Source: FE Analytics
Polls have narrowed over recent weeks, however, with the latest YouGov poll predicting that May will fall 21 seats short of a majority.
Coombs said the risk is now high enough for him to begin mitigating political risk and, as such, he has trimmed his exposure to UK domestics such as Lloyds, UK REITs and UK fixed income assets. Within Rathbone Strategic Growth Portfolio, his medium risk fund, his UK economic exposure has now fallen below 5 per cent.
“Pre-Brexit our domestic UK exposure was very low, then we increased it quite a lot after the Brexit vote. We felt the market was overly pessimistic on UK domestic stocks at that stage but, of course, a Labour win makes that looks very different,” he explained.
“Because the market has rallied since Brexit, in my opinion Brexit risk is elevated as well. I was already reducing UK because of Brexit risk because I felt the market became too complacent. Sterling has now snapped back and that makes me nervous.
Performance of currency vs US dollar over 1yr
Source: FE Analytics
“We are trying to retain intellectual capital and overseas corporate capital against a background of Brexit uncertainty. If you increase personal and corporate taxes on overseas capital, it seems to me Brexit risk will increase if Labour’s economic policy comes into place.
“I was already very low on the UK and I have just taken it even lower. I do see a Labour win as a similar risk to Brexit. We’re adopting the same strategy, really.”
If Labour were to gain a majority, Coombs said sterling is likely to weaken and that gilt yields would initially fall due to fears of a recession sparked by increased borrowing. Then, he added the likely inflationary impact of Jeremy Corbyn’s economic policies could cause gilt yields to rise significantly.
“Let’s start with fiscal policy. If you increase taxes the way Labour is proposing and put wealth taxes on homes, for example, I think you’re going to see the housing market come under pressure,” Coombs continued.
“That would have an impact on stamp duty, we might see an exodus of non-UK citizens working in the City, we could see corporation taxes increase, and we could see a lot of the headquarters in the UK move away.
“On a two-to-three year view, I suspect we’d see tax revenues fall. Borrowing would increase significantly and, just like anybody else’s balance sheet, if you keep on borrowing then your cost of borrowing rises because the risk increases. Bearing in mind we’re rated AA+ now, we could see a credit change, especially if we buy all of these nationalised industries as well.”
While he is cautious on the UK over the short term though, the manager is relatively constructive on the UK on a three-to-five year view as Brexit negotiations develop.
“I think in six months’ time when we start to see some more positive noises coming out of Europe from both sides, that would make me start to become more positive,” Coombs reasoned.
“I would want to see the German election out of the way in October. I think it all depends on whether Merkel gets back in so that she’s safe for another term, then we might start to see rhetoric come back down again.
“I still hope there will be a trade agreement between the EU and the UK. I think that’s the most likely scenario, I don’t think May will get what she wants but then I don’t think any party will get exactly what they want. However, I suspect we will get something that’s workable.
“The market is really going to struggle to discount that which is why I think there will be quite a lot of volatility around it which is unsurprising. It is very hard to be really bullish on the UK based on the picture I have just painted. Come October or November, we may have a little bit more fact.”
Of course, the Brexit negotiations will depend on who wins the election on 8 June. However, Coombs said both the Conservative and Labour parties have failed to provide much comprehensive fact in terms of their plans for Brexit negotiations and for the broader UK economy.
“We’re going to have to live in a world where there aren’t any solid facts for the next six months and I am willing to stay on the side-lines until I have something tangible to look at,” he explained.
“If May wins I think that’s helpful in that it reduces Brexit risk a little bit. I think if Corbyn wins the Brexit risk is exacerbated.
“We won’t have to worry too much about immigration if Corbyn wins - we will lose a lot of intellectual capital out of the UK because we’ll have taxed them too much. It will be an emigration problem not an immigration one – both in terms of capital and individuals. That’s my biggest concern.”