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The Independent Online
It is time to do some more thinking about the state of the political stakes at the moment and what it means for the markets. I am indebted to BZW for the graphic (right), which plots the state of consumer confidence (as measured by Gallup) and how it relates to the election cycle. The current view in the City, as I mentioned a few weeks ago, is that a Labour victory is already discounted in prices.

Indeed, the latest fashionable idea to explain away the recent surprising strength of sterling is the notion that Labour is more committed to European monetary union than the current Government. This, so the story goes, is what is underpinning the currency's value.

But don't be fooled into thinking that the election result is quite the foregone conclusion it is made out to be. One thing the Conservatives have never been bad at historically is managing the economic cycle for electoral advantage. And while they may have left it rather late this time around, don't think that the same factors are not now at work.

The fact that consumer confidence is now rising is hardly an accident. The tax cuts, implemented in April, are starting to feed their way through, house prices are starting to edge up again, unemployment continues to decline, and the consumer is again beginning to spend more. This week's base rate cut should also sustain demand.

Whereas 18 months ago all the talk was of the miraculous export-led recovery that followed our expulsion from the ERM, now manufacturing output and exports are slowing down and it is the consumer sectors which are leading the way.

The leisure, pubs and media sectors of the stock market have outperformed nearly every other over the past year.

Coincidence? Not exactly. As the BZW chart suggests, we are well into the season of pre-election massaging of consumer confidence. Note how the confidence index peaked last time in 1987 and 1992, which just happened to be election years. The same thing happened in 1982, if you look back that far.

What is true is that the absolute level of consumer confidence, as measured by the gap between those feeling good and those feeling bad, is lower this time round than in the earlier cycles. This underlines the fact that the Tories this time have left themselves a bigger hill to climb. Just as worrying for them is the fact that the rising trend in consumer confidence - which actually started in 1994 - is not yet being translated into approval of the Government in the way it has always done in the past.

Lingering disillusionment with the Government's competence since Black Wednesday, the unpopular tax increases and the splits over Europe are no doubt the main reasons.

But even so, it is no wonder that senior ministers like Michael Heseltine are still not yet ready to write off the election. They know that election success and the feelgood factor are closely correlated, and that the real contest - which again will revolve around what a Labour government would mean for tax levels - has yet to begin. The confidence index is closely correlated with the obvious variables affecting people's economic welfare: unemployment, house prices, inflation, interest rates and disposable incomes.

The City too knows that this is how the world works. For all the confident talk about a Labour victory already being discounted, my guess is that the political "risk premium" which is now being factored into the price of gilts and equities has almost certainly not yet peaked.

That in turn is what is likely to keep gilts up at least around their current levels (of 8.0-8.5 per cent) and hold back much in the way of a further advance in the London stock market. One way to measure the extent of the political concerns is to track the yield ratio, the differential between the yield on gilts and the yield on shares.

You would expect it to rise as political uncertainty increases. And that is what in fact has been happening. The ratio has been rising most of this year. It is up from just over 2.0 times in January to just over 2.2 times now.

Two other points to note in the consumer confidence graph. One is that, while confidence rises and falls in clear cycles, the balance of pessimists versus optimists in the Gallup survey is almost always a negative one. We are by nature a rather gloomy nation.

The second thing to note is how confidence always falls just after the election as the new government puts away its promises of better times ahead and concentrates instead on pushing through all the unpopular measures that it forgot to mention during the election campaign early on in its term of office.

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