10 May 2010 | Colin Renton

Hung Parliament Leaves Investors Dangling 

The reaction of equity and currency markets to the inconclusive outcome of the General Election suggests that recent uncertainty is set to persist – at least until the shape and political persuasion of the new government becomes clearer.

Volatility had already increased in the days leading up to the ballot, as the likelihood of a hung parliament intensified. And the unpredictability was exacerbated by concerns that the woes currently afflicting the Greek economy might spread.    

Over the coming weeks and months, we can expect to see growth in horse trading among politicians rather than bull and bear activity by investors. A hung parliament means uncertainty. And history shows that markets react badly to any lack of clarity.    

The FTSE 100 sat at 5,780 on April 6, the day Gordon Brown visited Her Majesty the Queen to request dissolution of parliament and fire the gun on the election race. On Friday May 7, as it became clear no party would have an absolute majority, the market opened with the index around 5,200.

In the intervening month, other factors had played their part in applying downward pressure – Greece being bailed out, economic data from China causing some concern, and currency markets suffering extreme moves. But, it was events at the ballot box that were the main focus.     

Even once the question of who wields the real political power is resolved, prospects for investment markets will remain unclear. Neither of the two largest parties can claim that markets perform better under their stewardship.   

A 2009 study by the Centre of Policy Studies  suggests that, historically, equities have performed better under the Conservatives than under Labour. The report states that market losses have ranged from 8% to 13% during Labour governments since the war, while markets posted significant rises under the Conservatives in 1951-64 and 1979-97.

However, during the period 1970-74, the Conservatives fared as poorly as Labour and the dubious record for the worst stock market performance during any government of the 20th century belongs to Neville Chamberlain’s Conservatives in the 1930s.

In currency and government bond markets, a hung parliament is viewed as a negative outcome and could lead to Britain’s credit rating coming under the microscope. This is because the absence of an absolute majority reduces the likelihood of the necessary measures being taken to reduce the UK budget deficit.

The absence of a formal plan could have a negative impact on the price of gilts and could also add to the pressure on equities. The political uncertainty might also depress sterling although this, at least, has the silver lining of delivering a boost to exporters.

Clearly, uncertainty is not welcome. Nevertheless, the possibility of a coalition government need not be bad news. After all, Germany is commonly regarded as the Eurozone’s most stable economy, and Sweden is frequently held up as a model worth replicating. Both, of course, are run by coalitions.