Your Money: New Labour: friend or foe?
With a general election on the horizon, Charles Maisey examines the likely prospects for investors under a government led by Tony Blair
Wednesday 26 June 1996
After 17 years of Conservative government, many investors will have forgotten the potential impact of a change of government on their investments.
Since 1979, fundamental reforms such as the abolition of exchange controls, the reduction of taxes on savings (from a peak of 98 per cent) and the introduction of new savings opportunities (personal pensions, PEPS, Tessas, for example) have influenced investment flows. More recently, low interest rates may have tempted investors out of bank and building society accounts into high yield equities, at a point when the tax regime may become less benign. Certainly, PEP sales have been buoyant while entrepreneurs and owners of private companies have been selling their businesses to take their capital gains now, anticipating higher taxes under Labour.
To forecast the tax regime after the election is foolhardy but investors will inevitably try to make prudent judgments of likely trends.
However, the historic evidence is that long-term secular trends for the economy cannot be influenced materially by politicians, whether Mr Blair or his deputy John Prescott, and long-term investors should not be "spooked" simply by the prospect of a Labour government. Equally the worst investment decisions are typically made for taxation reasons alone.
In terms of strategy there are three major factors to bear in mind - currency, inflation and regulation.
First, the absence of exchange controls - and the probability that they could not be reintroduced - places a constraint on macro-economic policy. The differences between the two main parties in terms of overall demand management is therefore probably quite small as a result of the freedom of international capital to flow in and out of the UK.
That Labour might wish to join the European single currency is a further constraint to inflationary policies. However, the loss of a monetary policy tool in terms of setting a target exchange rate requires the major burden of demand management to be borne by fiscal policy (both taxation and subsidy). This would reinforce the second factor.
Economic planning and regulation are traditionally cornerstones of Labour policy. Commitments to the Social Chapter and the national minimum wage are examples of likely micro-economic policy under Labour, and could well be accompanied by more emphasis on regional policies. Greater regulation and interference for domestic industry must be expected. The costs of these policy choices are inevitably hidden behind the smokescreen of bureaucracy, but their impact in higher costs and lost incentives should not be overlooked.
Lastly, a new Labour government will have spending commitments and promises to fulfil. A relatively buoyant economy leading to buoyant tax revenues is a necessary objective. If Conservative economic policy has aimed at low inflation and a competitive employment market, Labour would seek faster growth and lower unemployment.
The recent OECD report suggesting that the economy has scope to sustain a faster rate of growth might actually encourage either a Conservative or a Labour administration to be more lax with policy. New Labour has stressed its commitment to prudent sustainable policies. However, based on past experience, the City is tempted to conclude that a Labour Chancellor would be more inclined to take chances with inflation by not raising interest rates should, say, the currency come under pressure.
Looking at taxation policy, there is a confusing series of claims, undertakings and retractions from Labour at present. However, there are pointers which could well be relevant, regardless of the victorious party at the election. Since 1992, the individual has borne the major burden of the adjustment which the economy required, both through higher taxation (income tax and VAT) and the devaluation of sterling after leaving the ERM.
The devaluation resulted in a shift in the terms of trade, depressing real incomes and creating the environment for companies expand profit margins on exports. So the corporate sector has enjoyed buoyant conditions, and more recently has proved itself adept at mitigating its tax liabilities, as the shortfall in VAT receipts indicates.
A shift to higher corporate tax might lose Labour votes and in the case of the utilities and a windfall tax, find favour in many voters' minds.
The conclusions are therefore clear. The threat of faster growth with the attendant risk of higher inflation argues against long-dated gilts and bonds. Higher rate taxpayers may well retire into index-linked gilts.
Equity portfolios should move towards stocks which can generate superior growth in the long term, rather than high yields. If dividends are taxed more heavily, either in the hands of the investor or through change in corporate taxation, the valuation of income stocks is likely to suffer.
Conservatives have already established the precedent of reducing the ACT credits and further action in this would be a hidden tax. For private investors, capital gains may be taxed more heavily, but the timing of the tax liability can at least be determined by the investor's choice of when to sell.
A combination of companies focused on growth industries, with an international flavour, would contribute towards protecting portfolios from currency weakness while exploiting industrial trends.
Pharmaceuticals, media and international engineering are examples. Domestically, infrastructure projects (housing, hospitals) would reduce unemployment and suggest that building companies would benefit, though perhaps not road-builders on environmental grounds.
In the service sector, employers of low-paid workers - catering, nursing homes and the like - would suffer a margin squeeze as wage bills rose.
The high yielding utilities sector would have limited attractions, particularly at current levels, which include a degree of takeover premium in many cases.
Stock selection can contribute to achieving the desired geographical bias in a fund as well as a rational spread of sectoral interests.
For example, RTZ generates no profits in the UK, while Reuters, SmithKline Beecham and Siebe are world leaders in their respective industries.
Equally, a shift of funds into overseas unit and investment trusts should be considered. Our in-house model has recently raised the proportion held in overseas markets to 33 per cent for a growth portfolio, with an overweight exposure to the Far East, Europe and Japan.
An element of the risk of a change in government may be discounted by UK financial markets given their relative under-performance in 1996.
Electoral uncertainty and the fear that the Conservatives are increasingly managing the economy for political ends has had an impact on values. It may also be the case that markets are beginning to anticipate the problems that an incoming government will fare regardless of political complexion.
There are signs of a continuing structural Budget deficit, poor levels of education and skills in the labour force and the prospect of too buoyant an economy increasing inflationary risks - to mention three issues.
Seasoned investors could be tempted to say that little appears to have changed over the years in terms of prudent investment policy and themes. That is probably true, though after four Conservative governments, portfolios may well have drifted from the long-term path of prudent diversification. If historians look back at the 1980s and early 1990s and characterise the apparent revolution in attitudes and performance in the economy as "a rally in a bear market", an early analysis and review of portfolio investments could be very timely.
The author is a director of the stockbroking firm Quilter & Co (Tel 0171-662 6262)
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