Morgan Stanley told investors that another general election towards the end of 2018 was likely once Theresa May’s government realised it could not secure the Brexit deal it wants and the Conservative party began to fall apart, opening the door to Labour taking power.
The nationalisation of key industries, higher taxes and a shift in spending priorities towards low-income households under Corbyn’s leadership could damage valuations of UK companies, the US bank warned.
“The UK is in the midst of a double whammy of uncertainty in the shape of Brexit and a fragile domestic political situation. Taken together, these two factors – which are interrelated to some degree – cast a long shadow over the policy backdrop and economic outlook of the UK,” the report from Morgan Stanley’s European equity team read.
“For the UK market, domestic politics may be perceived as a bigger risk than Brexit,” the bank told clients.
“From a UK investor perspective, we believe that the domestic political situation is at least as significant as Brexit, given the fragile state of the current government and the perceived risks of an incoming Labour administration that could potentially embark on a radical change in policy direction.
“Against this backdrop, even if we see good progress in the Brexit negotiations, the scope for UK sensitive assets to rally may be muted, unless we also see an improvement in the government’s position in opinion polls.”
Morgan Stanley said British utility companies, especially water and power companies, were most at risk from a Labour government, but also warned postal services, telecommunications and travel companies could be affected.
Higher taxes and an increase in corporation tax to 26% might damage British financial services, Morgan Stanley warned.
“Spending priorities... shift in favour of low-income households and the public sector and away from outsourcers and defence companies,” the report continued. “Higher low-end wage growth could also impact service-oriented companies with low margins, such as retailers.”
Morgan Stanley warned of the UK’s fragile political situation, saying: “For much of the past 30 years and more, a change of government ultimately had a relatively limited impact on the UK equity market, as policy settings didn’t change too dramatically. However, this may not be the case if we see a Labour government take power under its current leadership, given its very different policy approach.
“It is certainly plausible that the Labour party could ultimately moderate some of its more radical policy ideas; the alternative could be the most significant political shift in the UK since the end of the 1970s.”
In forecasts for bad scenarios for UK stocks, Morgan Stanley highlighted the prospect of the Brexit process unravelling.
“If the UK and EU find insufficient grounds for compromise and/or we see a change in the domestic political backdrop in the UK which leads to a new prime minister (possibly from either party). Fresh uncertainty around a trade agreement starts to cloud the economic outlook in the Euro area in addition to the greater woes envisaged for the UK,” the report said.
“Even though the UK economic news flow hasn’t been as bad as some feared, the UK equity market has underperformed materially over the past year. Its relative valuation is now down to its lowest level since the height of the TMT [technology, media and telecoms] bubble.
“Given this depressed backdrop, it is quite plausible that we see a relief bounce in some UK assets if and when the Brexit negotiations move on to the next stage. However, we think it unlikely that any such move would be particularly long-lasting, given that uncertainty levels look set to remain elevated for much of the next year or more.”
A Labour spokesperson said: “The next Labour government will provide the major boost to investment that business groups like the CBI and the FSB have been calling for, protect 95% of people from any tax rises and ensure our public services work for people not profiteers.
“The banks and hedge funds will not be allowed to bring our economy to its knees again. Labour will put an end to the rigged economy that benefits only the super rich, to build a society that works for the many not the few.”
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