Why Scotland’s ‘Will of the Nation’ Likely Won’t Sway Stocks

Editors’ Note: Our political commentary is intentionally nonpartisan. We favor no politician nor any political party or initiative and assess political developments for their potential economic or market impact only.

Results from last Thursday’s UK local elections took a few days to trickle in given some COVID-related counting delays. But now they are in, so cue the multitude of fearful headlines. For even though they were in line with expectations, those expectations included the Scottish National Party (SNP) winning the Scottish Parliamentary vote and—together with the pro-independence Green Party—claiming a mandate for a second Scottish independence referendum. That makes this the rare recent election that extends uncertainty rather than reducing it, which is worth watching from an investment standpoint. However, we think all of this week’s “Scexit” dread is premature. The process from here will be long and grinding, with any potential surprise power fizzling gradually. We don’t think this is bearish for UK or global markets.

The SNP fell one seat short of a majority, winning 64 of the Scottish Parliament’s 129 seats. The pro-Union Conservatives and Labour took second and third, respectively, winning 31 and 22 seats. That left eight for the Greens, four for the Liberal Democrats and zero for the upstart Alba, an SNP rival party started by scandal-plagued former SNP leader Alex Salmond. But due to the complexities of Scotland’s electoral system, which mixes constituency and at-large seats, pro-independence parties didn’t win a majority of votes cast—close, at 49.2%, but not quite.^[i]

But politicians have a knack for not letting technicalities like facts get in the way of a good narrative, so SNP leader Nicola Sturgeon said the results proved a referendum was “the will of the country.” That seemed to be news to UK Prime Minister Boris Johnson and Scottish Conservative Party leader Douglas Ross, both of whom pointed out that Sturgeon herself had talked down a referendum in the campaign’s final days. Johnson also reiterated his long-running opposition, saying “a referendum in the current context is irresponsible and reckless.”

So where things go from here isn’t clear. UK law requires government approval for an independence referendum. Sturgeon said there is “simply no democratic justification” for Johnson to refuse, but so far he and cabinet ministers aren’t relenting. Instead, he invited Sturgeon, Welsh First Minister Mark Drakeford and Northern Irish joint First Ministers Arlene Foster and Michelle O’Neill to what pundits are calling a “save the union summit.” Lovely as that sounds, experience tells us it will be a forum for grandstanding that all parties say justifies pursuing their pet goals—and that doesn’t settle the referendum approval issue.

Beyond that, Sturgeon could push for a referendum without the UK’s approval and hope the courts approve it retroactively. But there are huge drawbacks to this. The EU, which Scotland would presumably hope to rejoin if it gained independence, would likely frown on an extralegal move like this, if the reaction to Catalonia’s vote a few years ago is any indication. Hence, Sturgeon has generally resisted this temptation. She is also prioritizing COVID relief and now floats 2023 as a potential referendum window. So we think it is safe to say investors won’t get clarity in the near future.

But that also means speculating about what will happen—including what a vote to secede would do to the UK economy and markets—is fruitless. Already, we are seeing coverage that hypes all the alleged negatives, which echoes all of the handwringing about a possible Brexit in the run-up to that referendum five years ago. At this point, it doesn’t matter whether pundits are right that divorce talks would make Brexit negotiations look like a garden party. The litany of negative economic projections and dire warnings about currencies, debt, banks and Scotland’s dependence on North Sea oil are also similarly immaterial at this juncture—to see why, just look at the dreary report card for all of the dire Brexit warnings. Some came true, some didn’t, but all were priced in by the time Brexit actually happened. We suspect it would go similarly with a “Project Fear” campaign against Scottish independence.

For markets, it doesn’t matter whether a development like Brexit or Scexit is inherently good or bad. Heck, even that is an opinion—unprovable, given the lack of any counterfactual. All events create winners and losers. But the more headlines hash and rehash the potential losers, the more surprise power fades, and the more it all gets priced in. This process can weigh on sentiment and dampen returns, which we think contributed to the UK’s underperformance in the run up to Scotland’s 2014 referendum. But it doesn’t mean a vote for independence is actually negative. Rather, we think it means there is a strong likelihood that just holding the referendum ends uncertainty, letting markets move on regardless of the outcome. Again, see Brexit with any questions.

In the meantime, there is another UK political wrinkle to keep an eye on, because Scottish pro-independence parties aren’t the only ones who had a banner Election Day. Johnson’s Conservatives trounced Labour in most councils and a widely watched by-election for a national Parliament seat in Hartlepool, which is in the traditional Labour heartlands. That isn’t predictive of national elections, of course, but it seems to have energized the Conservatives: In Tuesday’s Queen’s Speech, which marks the formal opening of a new Parliamentary session, they announced their intent to repeal 2011’s Fixed-Term Parliament Act. If successful, that would bring back snap elections and potentially accelerate the next contest (currently due by late 2024). This isn’t a prediction, but with the Conservatives cresting and Labour disintegrating, an early election makes strategic sense, which may ratchet up UK political uncertainty in the near term.

None of this is bearish, in our view. We see it as an additional sentiment factor to weigh and perhaps an added headwind on top of the UK’s strong tilt toward value-heavy sectors. Expectations for the UK are high right now due to its strong economic recovery from lockdowns, making it important not to get too carried away.