Don’t hang on to shares if it’s a hung parliament

T he UK stock market ran out of upward momentum in April. Wall Street’s S&P 500 index serves as a useful reference point. Gains on our FTSE All Share index either matched or exceeded S&P 500 gains in the third and fourth quarters of 2009 and the first quarter of 2010.

Our relative strength abruptly weakened in April. The All Share index slipped by 2 per cent while the S&P 500 gained 3 per cent. Problems in Greece and Portugal probably contributed to this reversal. But some slippage can also be linked to next Thursday’s vote. No surprises here because UK shares are typically weak in the run-up to a national election.

I suspect that we will not see a meaningful recovery before the election. Investors throughout the world are quite concerned about our ability and political will to deal with an enormous debt burden. A few extra words on the campaign trail will not make this problem suddenly disappear.

Another concern that investors face is a possible hung parliament. Some commentators believe current prices already discount this risk. I do not share their view. Hung parliaments are like mine fields chock full of unexploded mines. I fear shares could easily drop by a double-digit amount at the first whiff of conflict between opposing parties about how to attack the debt problem. I do not expect huge declines like we saw in the aftermath of our last hung parliament in 1974 (see box) but the chance of some pain certainly does exist.

Happily, there is one bright ray of sunshine in my doomsday scenario.
I believe a hung parliament is less likely than current polls suggest. Both main parties argue that a vote for the Liberal Democrats will increase the likelihood of a hung parliament. I suspect this argument will gain traction among swing voters in the next few days. Fear about the potential danger of a hung parliament will decrease Liberal Democrat votes.

For the moment, I continue to hold my shares. But if Thursday’s vote results in a hung parliament, I probably will shift to defensive mode and close some positions.

On the other hand, if Labour or the Conservatives win with a clear margin of victory,
I suspect the effect on shares will be minimal. Each party may have a different approach to reducing the deficit but the presence of a clear plan will probably reassure most investors.

Nick Clegg’s strong performance caught many by surprise. But, for me, the biggest surprise in this campaign is that Gordon Brown still remains in the running. Polls suggest he is unpopular with voters, even if we exclude fall-out from last week’s “bigot” gaffe. Worse still, for a man who claims to be a safe pair of hands in troubled times, his economic record is poor.

One of Brown’s early decisions was to tax dividend payments to pension funds. He thought it would be politically safe because it would hit big investment institutions, not voters. As we now know, his decision helped to decimate everyone’s retirement pension.

He also sold off part of the nation’s gold hoard at a price that was about one-third of the recent peak. He compounded his poor decision by pre-announcing the sale, which depressed prices even further.

Most investors agree his tripartite system of financial regulation is seriously deficient. It divides responsibility between the Bank of England, Financial Services Authority and the Treasury. The results have been disastrous. Northern Rock rapidly expanded on the back of a flawed business plan. The Royal Bank of Scotland “bet the ranch” on an ill-timed acquisition.

But the biggest problem of all is his massive spending programme. No money was left in the kitty for a rainy day. The country is now broke. It will take a decade of pain until a future government puts things right.

Stock market historian David Schwartz is an active short-term trader writing about his own trades and strategies. Send any comments or suggestions to tradersdiary@ft.com

A repeat of 1974?

The last election to produce a hung parliament was in February 1974. Shares rose 8 per cent in the month before polling day because the Conservatives were expected to win. But, after the result, the FTSE All Share index declined 21 per cent in the following month and 39 per cent within six months. Might this happen again? Probably not. Recall that 1974 was a unique period in UK economic history. A steep bear market in most western countries had been running for more than a year, triggered by a painful worldwide recession and inflation. Aggressive trade unions drove wage inflation up to an annual rate of 30 per cent. Taxes on investment income reached 98 per cent. Rising interest rates in the US threatened to affect our domestic rates policy. So, even though hung parliaments are not good for investors, we are unlikely to see a rerun of 1974, no matter what happens next Thursday.