Could July 4 Elections Light Up UK Equities?
Key findings
- Since 1970, U.K. equities responded mildly in the year following an election. After 1997, however, Labour wins typically spurred short-term outperformance for U.K. equities versus EU markets, while Conservative wins had the opposite effect.
- Both major parties are supporting artificial intelligence (AI) to energize the nation’s economy. Using the MSCI Thematic Exposure Standard, we assessed the AI exposure of U.K. stocks and how that could change.
- Labour and Conservatives are approaching the transition to sustainability at different speeds. We use MSCI’s climate metrics to gauge how U.K. stocks have fared.
As the U.K. gears up for general elections on July 4, the two leading parties, Labour and Conservative, have placed economic growth, post-COVID-19 recovery and inflation management at the heart of their manifestos.[1] Polls show Labour leading Conservatives (39% vs. 20%, as of June 30, 2024,)[2] and among 18- to 64-year-olds, while Conservatives are ahead with voters over 65. Although it remains to be seen how the current polls play out and how the next government's campaign pledges translate into policy, using MSCI data, we assessed possible impacts of the prevailing political winds on the U.K. equity market post-election.[3]
UK equities have reacted with typical British understatement after elections
We measured the volatility of the U.K. equity market, using the monthly returns of the MSCI United Kingdom Index, between Dec. 31, 1969, and May 31, 2024. Average annualized volatility was 21.4% over this period.[4] For the 12 months after a parliamentary election, volatility was 20.9% and, for the three months post-election, 21.6%. The historical record indicates that the U.K. equity markets have been largely unmoved by election results.
We do observe a directional reaction by U.K. equities, however, when we limit our analysis to the last seven elections. We compared the performance of the MSCI United Kingdom Investable Market Index (IMI) and the MSCI Europe ex UK IMI between May 1997 and December 2020. We found that when Labour won, the MSCI United Kingdom IMI underperformed the MSCI Europe ex UK IMI, on average, by 1.7% over the month after the election. By the three-month mark, however, the tide had reversed, and the MSCI United Kingdom IMI posted average outperformance of 1.8% versus EU equities.
When the Conservatives won the election, U.K. equities underperformed, on average, by 1.1% one-month post-election and by 2.8%, on average, after three months. Up to 10 months, on average, after elections, Labour wins resulted in less-negative active returns than Conservative wins.[5]
Since May 1997, Conservative wins have led to short-term underperformance
Data period from May 31, 1997, to Dec. 31, 2020. Exhibit shows the performance of the MSCI United Kingdom IMI versus the MSCI Europe ex UK IMI for the 12 months following U.K. parliamentary elections.
We found, using MSCI equity risk models to analyze data from Dec. 31, 2000, through May 31, 2024,[6] that a geographic hedging strategy, in which investors added U.S. allocations to their U.K. equity portfolios, could have introduced diversification benefits to help manage risk related to short-term uncertainty in U.K. equities. Over this period, the MSCI USA IMI had the lowest correlation to, and a similar level of risk as, the MSCI United Kingdom IMI.
Low US-UK correlations suggested diversification opportunities for UK equities
Data period from Dec. 31, 2000, to May 31, 2024. Ex-post risk was calculated on monthly returns over the analysis period. Ex-ante risk and correlations were calculated using MSCI EFMGEMLT L and EFMGEMTR D factor models as of June 14, 2024. All numbers are annualized in USD. Correlations were calculated versus the MSCI United Kingdom IMI.
The MSCI equity models also show that investors with a sector-based investment process could have considered a tilt toward defensive sectors, such as energy, consumer staples, health care and utilities, to help manage short-term volatility in the U.K. equity market. The MSCI UK Defensive Sectors Index outperformed its parent by 0.5% annually and exhibited lower risk — 14.7% versus 17.2% — between Dec. 31, 2000, and May 31, 2024.
Growth and the AI opportunity
Both leading political parties are prominently featuring AI in their election manifestos and assuming it will play a pivotal role in propelling future economic growth.
Using the MSCI Thematic Exposure Standard of the AI theme, we measured U.K. companies' current economic links to AI technologies.[7] In November 2022, when ChatGPT was first released, the MSCI United Kingdom IMI had the lowest AI exposure compared to the MSCI Europe ex UK IMI, MSCI World ex UK IMI, MSCI Emerging Markets IMI and MSCI USA IMI. Over the last two years, U.K. equities have gained little ground, displaying a low baseline AI exposure, in both absolute and relative terms.
UK equities had lower exposure to AI than regional peers
The decline in the AI exposure of the MSCI Emerging Markets IMI occurred because, although the number of companies benefiting from AI technology grew, some companies' index weights decreased during the analysis period.
Should the AI manifesto policy initiatives become effective, sectors such as information technology, communication services, industrials, health care and financials would likely benefit in our model.[8]
Alternative energy: powering the way to net-zero
Labour has proposed the establishment of a new publicly owned company, Great British Energy, that would pursue the goals of reducing household energy costs and generating jobs and would be supported by a windfall tax on the profits of oil and gas companies. The Conservatives have indicated they would issue new oil and gas licenses alongside a gradual integration of sustainable energy sources. Although both parties are signaling greater support of sustainability and net-zero, a full transition to net-zero emissions would signify a major reduction in oil and gas exploration in the U.K.
The MSCI United Kingdom IMI's revenues from the extraction and production of oil and gas[9] were almost three times higher than comparable revenues in the MSCI Europe ex UK IMI at the end of May. Using MSCI climate data and metrics, we found that U.K. equities in aggregate had high carbon-emissions intensity relative to other markets in our analysis. The speed at which the U.K. moves toward transition carries ramifications for the U.K. economy and its equity market.
UK equities lagged other European markets in green progress
Data as of May 31, 2024. Carbon intensity = carbon emissions (Scope 1 + 2 + 3) divided by enterprise value including cash.
Post-election market surprises unlikely, but AI and energy landscapes could shift
Looking back to 1970, U.K. equity markets have historically displayed only minor reactions to election outcomes. In more recent years, Labour victories have yielded short-term positive moves versus EU markets, while Conservative wins have moved the market in the opposite direction.
Both major U.K. parties are now banking on AI technologies to invigorate the nation's economic growth, but they have divergent approaches to sustainable energy transition. With both AI and energy in the political spotlight, opportunities and risks associated with these stocks could be expected to remain in flux until the political landscape comes into clearer focus.
1 Labour's manifesto was published on June 13, 2024, and the Conservative's was published on June 11, 2024.2 “Who's ahead in the British polls?” The Economist, accessed on June 30, 2024.3 The U.K. is divided into 650 constituencies, each electing one Member of Parliament (MP) to the House of Commons. To form a government, a political party needs a majority of 326 seats, but vote share does not tie directly to seats won. For more information, please refer to Roderick McInnes, “General Election 2019: Turning votes into seats,” House of Commons Library Insight, Jan. 10, 2020.4 When we exclude from our analysis the election of 1974, which occurred during a bear market that hit the U.K. particularly hard, the average volatility one year after a parliamentary election was 17.4%. When we exclude both the 1974 and 2019 elections, the latter being the year that preceded the U.K.'s withdrawal from the EU, average volatility one year after an election was 16.3%.5 Results hold if we exclude the 2019 parliamentary election.6 We applied the MSCI EFMGEMLT L and EFMGEMTR D factor models.7 AI exposure gauges a company's involvement in the development, production or deployment of robotics and AI technologies based on business-segment revenues and other sources of business information. The modeling is described in “Indexing Change: Understanding MSCI Thematic Indexes,” MSCI Research, Nov. 22, 2019.8 These five have the largest sector weights in the MSCI ACWI IMI Robotics and AI Index as of May 31, 2024.9 We use data from MSCI ESG Research that indicates the maximum percentage of revenues (reported or estimated) that a company derives from the extraction and production of oil and gas.
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