An unprecedented shift to a hard-left government under Labour Party leader Jeremy Corbyn could signal harder times for businesses but also result in greater social change, according to Rathbones’ Ed Smith (pictured). 
The head of asset allocation research said while the firm is “not in the business of forecasting elections, especially when even the timing of the next one is hotly debated”, it had attempted to imagine how Jeremy Corbyn’s Labour could impact the economy and markets.
“Some believe that Corbyn’s bold new policies will usher in a more equal society, while others worry that his agenda will bankrupt the nation and drive businesses from these shores in droves,” he said.
“After extensive analysis, we feel both are likely to be wrong. But there are a few risks. Not least, a Corbyn-led government would polarise people, and people – unfortunately – influence investments.”
Smith noted that the FTSE All Share has markedly underperformed global equities since the early summer of 2017, when the Labour leader began to eat into the polling lead following last year’s snap general election.
Indeed, the UK index has risen by just 2.17 per cent since the election, compared with a 13.14 per cent increase for the MSCI World, as the below chart shows.
Performance of FTSE All Share since the election
Source: FE Analytics
The FTSE All Share has had a very tight relationship with sterling moves, oil prices and leading economic indicators in Asia over 20 years, according to Smith. However, underperformance more recently could be attributed to the ‘Corbyn factor’, he said.
While ongoing Brexit negotiations could explain some of the movement, but the stability of sterling suggests there is likely to be some other factor.
He said although Labour MPs tend to be anti-Brexit, the position of the party’s leadership is less clear with Corbyn himself having been openly hostile to the bloc over a 30-year career.
A victory for Corbyn was unlikely to mean greater clarity on Brexit, given the divisions in the party, warned Smith.
“This could be why the pound barely budged as Labour soared up the polls,” he said. “But it could also be that investors netted off a positive lift on the Brexit front with a negative impact from the potential for capital flight if Corbyn enacted a hard-left agenda.”
Smith added: “Certainly sectors most directly in the firing line of nationalisation have suffered more than others.
“UK utilities have underperformed global utilities by an enormous 24 per cent since the Conservatives’ polling lead peaked in April 2017 — three times the underperformance of the broader UK market.”
Performance of FTSE All Share Utilities since the election
Source: FE Analytics
Smith said while there are few examples of the transition from a right-leaning government to a left-leaning one having a significant impact on equity or bond markets, there had been no UK precedent of a shift to a hard-left government.
“It’s hard finding a precedent of a hard-left government coming to power anywhere in the advanced world over the past 30 years,” he explained.
The most recent example in was the election of hard-left politician François Mitterrand as French president in 1980.
However, this was greeted with a double-digit drop in markets, which remained erratic, and a widening of government bond yields relative to their German equivalents, which later recovered.
The French finance ministry was forced to devalue to relieve pressure on foreign exchange reserves from capital outflows, but this helped stem outflows while borrowing costs also later fell.
Unlike Corbyn, Mitterand was only interested in nationalising “ailing, unprofitable companies”, said Smith, which continued “haemorrhaging money” before finally being forced to apply austerity measures, cut state subsidies and raise taxes.
“Markets could run riot initially, but higher rates and a weaker exchange rate should limit capital flight,” he added. “And if, even after a period of folly, a Corbyn government jettisons its most left-wing reforms and courts private enterprises just a little, markets could recover very quickly. Of course, this requires Corbyn to allow centrist colleagues to join in the debate.”
Labour policies under Corbyn (pictured) offer some insight into what the potential impact could be. 
“The higher minimum wage is quite radical, but then the Conservatives have committed to a very large increase too,” Smith said. “Of course, there are the nationalisations of the water companies, the National Grid and the Royal Mail, which are likely to prove costly.
“But they are not really a major affront to free market economics because these industries are natural monopolies – you can’t choose your water provider.”
Labour plans to increase the national living wage, while benefiting 7.1 million workers, would cost £14bn per year and could potentially “knock about half a percentage point off the average FTSE 250 company’s profit margin”, said Smith, but may not influence inflation too much.
Meanwhile, although economists are sceptical about the amount a Labour government could raise through taxation, shadow chancellor John McDonnell’s fiscal rule of covering current spending through taxes within five years echoes previous chancellor George Osborne’s approach.
“McDonnell’s innovation is a knockout when interest rates are near zero and monetary policy can not be called upon to stimulate the economy during a recession,” Smith added.
A rise in corporation tax from 19 per cent to 26 per cent in 2020 is “highly likely” to have adverse effect on wages and investment but “may be less harmful to long-term growth than some fear”. It could also prompt businesses to relocate elsewhere post-Brexit.
Proposals to increase infrastructure spending could, however, have a positive impact if it is invested in the right areas, the Rathbones strategist said. However, nationalisation of some companies could cost more than £100bn based on current market capitalisations, while the ability of the civil service to manage those companies remains questionable.
“Is the Labour manifesto a Trojan horse that will usher in widespread nationalisation, the state–directed allocation of capital and the undoing of economic liberalism?” asked Smith.
“In that case international businesses couldn’t be blamed for exiting in droves and the UK’s cost of capital will rise considerably.
“Or is it more of a half–baked attempt at progressivism from a couple of political throwbacks hoping to ride the current wave of populism into No. 10?
“In which case, it probably won’t be as bad as some investors think. And, through the party’s infrastructure-based economic stimulus, there’s even the chance that it could turn out for the better.”