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It is official: Prime Minister (PM) Boris Johnson is out, announcing his resignation after a torrid week of ministerial resignations and scandal. As we write, he remains in office as caretaker PM pending a Conservative Party leadership election, and financial publications we follow are full of speculation about what the change means for the UK economy and markets. We do think rising uncertainty has weighed on UK stocks lately, and we think it is fair to presume falling uncertainty will be beneficial. But we wouldn’t go beyond that and argue the leadership change points to big policy changes with a big impact.
In our view, market movement over the past three days shows the power spiking—and falling—uncertainty can have. On Tuesday, when the parade of resignations started, the MSCI UK Investible Market Index fell -2.7%.[i] But on Wednesday, as the trickle turned into a flood and it became increasingly clear to most observers we follow that Johnson wouldn’t survive the week, UK stocks rose 1.2%.[ii] They echoed that feat Thursday as Johnson stepped down.[iii] Now, we aren’t arguing this is because stocks disliked the outgoing administration—far from it. Our research shows stocks don’t care one whit about political personalities or which party is in power. But high and rising uncertainty can hit sentiment hard, which discourages risk-taking and investment. That can show up in negative stock returns. As the eventual resolution gradually becomes clear, we think it lets investors eye the future and form more realistic probabilities for which policies stand the best chance of passage.
Policy is at the centre of much of the discussion we have seen, due in large part to new (and potentially interim) Chancellor Nadhim Zahawi’s many media appearances touting tax cuts Wednesday morning.[iv] He hinted strongly at cancelling now-former Chancellor Rishi Sunak’s pending increase to the corporation tax rate, and we have seen speculation that he could attempt to scrap the National Insurance Contribution (NIC) increase that took effect this year or restore the inflation-indexing of income tax bands, which Sunak had frozen until 2026.[v]
We suggest not getting excited about any of this. For one, our research finds tax changes don’t have a pre-set relationship with economic growth or stock market returns. When former PM David Cameron and former Chancellor George Osborne cut corporation taxes in the 2010s, it didn’t meaningfully boost business investment. We didn’t view raising these taxes as likely to have a deleterious effect, and preventing those raises merely extends the status quo. On the personal income side, whilst households would no doubt welcome relief from higher living costs if tax band thresholds rose or the NIC rise reversed, we have also found that income tax changes have at most a tiny effect on household spending. Our research also finds that market returns following tax changes have no set pattern. So whether you feel cheery over the prospect of lower taxes or gloomy about what that might mean for public finances—or any other emotion—we don’t think the market impact would likely be huge.
Then too, it isn’t clear to us that meaningful legislation stands a high chance of passing. Perhaps the energy sector windfall profits tax, which Sunak announced in May but hasn’t yet passed Parliament, bites the dust. But passing anything major would require a party presently beset by deep divisions to overcome the internal political gridlock that we have observed to be setting in recently. Even that outcome presumes the next Conservative leader chooses to serve out the remainder of this Parliament rather than seeking a fresh mandate via a snap election, which Labour already seems to be pressing for.[vi] Even with the history of leadership changes giving UK political parties a temporary polling boost, it isn’t clear to us that the Conservatives could overcome their current deficit to Labour, which has widened in recent weeks.[vii]
So, whilst Johnson’s resignation adds some clarity, we still see significant room for uncertainty to fall over the next few months—which we think is likely to give some modest tailwinds to UK stocks. Soon we will have the shortlist of candidates vying to succeed Johnson. That list will narrow during the leadership campaign and the initial rounds of balloting, eventually winnowing to a contest between the top two. This process will likely wrap up by late summer or early autumn, based on the reporting we have seen. Once that leader is in place, we will get clarity on whether they will seek a new mandate—adding the uncertainty of a snap election—or attempt to carry on until 2024, when the next general election is due. As this all plays out, markets will be able to gradually assign probabilities to the various potential outcomes, which we have found to be key to their ability to move on.
[i] Source: FactSet. MSCI UK IMI price return on 5/7/2022.
[ii] Ibid. MSCI UK IMI price return on 6/7/2022.
[iii] Ibid. MSCI UK IMI price return on 7/7/2022.
[iv] “Will Nadhim Zahawi Change Tack on the Economy?” Staff, BBC News, 6/7/2022.
[v] “Spring Budget 2021: Personal Allowance and Higher Rate Threshold,” Antony Seely, House of Commons Library Research Briefing, 30/6/2022.
[vi] “Labour Leader Keir Starmer Issues Blunt Response to Boris Johnson Resignation,” Adam Maidment, Manchester Evening News, 7/7/2022.
[vii] Source: Politico, as of 7/7/2022.
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