The markets in the City gave a cautious welcome to the new coalition Government, with both bond prices and share prices rising and sterling strengthening.
On Wednesday morning, as details of the policy commitments and cabinet positions slowly emerged, the FTSE posted slim gains, gilt prices rallied and the pound, which had been strengthening since Tuesday afternoon, when a Conservative and Liberal pact started to look increasingly likely, gained ground against both the pound and the dollar.
However, City experts warned investors not to read too much into these modest gains. Mark Harris, head of multi-manager at Hendersons said: “The market is supportive of and encouraged by these political events. But this is in many respects a ‘relief rally’. One piece of uncertainty has been removed from the puzzle which has to be good news. But we are still awaiting further details, and everyone will want to see how this coalition works in practice.”
The markets clearly welcomed the fact that one of the priorities of the Government was to start reducing the UK budget deficit. This view was endorsed by Mervyn King, the Governor of the Bank of England, who described plans for £6bn in 2010 as “sensible”. He also said the new Government’s deficit reduction plan was “strong and powerful”.
The strongest recovery has perhaps been in gilt prices. On Wednesday afternoon, 10-year Government gilts were trading at about 3.8pc, still significantly higher than the 2.9pc being paid on 10-year bonds issued by the German government.
George Godber, a fund manager at Matterley Asset Management said: “These yields have come in considerably, moving by about 50 basis points in a day. There was a danger that UK gilts would be trading at a 1.5pc premium to comparable German bonds. A week ago these gilts were yielding more than 4pc so this is a good move.”
But as Mr Harris pointed out, UK stock markets and currency markets are also being affected by other global factors. For example, the precarious economic recovery and continued concern about sovereign debt in many Eurozone countries. The Bank of England inflation report, published on Wednesday also had an effect, causing the pound to lose some of its early gains.
Mr Harris added: “As David Cameron made clear when he entered Downing Street there are difficult times ahead. This will affect all investors over the next few years.”
Andrew Wilson, the head of investment at wealth advisers, Towry, agreed that the outlook remained uncertain for many British savers and investors: “Taxes are going up and spending plans are going to be cut back, which will result in much slower economic growth. However this may be good news for investors as it means that interest rates will most likely stay low. This is positive for equities, bonds and property – as well as mortgage holders, though bad news for cash savers.”
For those looking to invest on this “cautious optimism” where would be a good place for their money?
Mr Harris said: “Markets are likely to remain volatile, so we would recommend that investors continue to take a fairly defensive stance.” He said he favoured funds and equities that were supported by a strong yield. “Neil Woodford’s income funds look like a good buy in the current conditions. If you are buying in the UK, I’d stick with quality while the economic recovery remains fragile.”
Overseas, Mr Harris favour US funds and stocks. “American equities are likely to benefit from the stronger dollar. But let’s be frank, when looking overseas it is more of a case of which geographical area looks the least ugly. Europe still has its problems and while we remain positive on Asia and emerging markets over the long term we don’t think that now is the time to be buying. We are holding off until later in the year.”
Mr Godber said that investors should bear in mind that many of the shares in the FTSE 100 looked very good value indeed. He said yields are looking attractive on equities, particularly when compared with returns on cash.
However, he warned that the share prices of the UK banks fell quite sharply, when the coalition was first announced. He blamed this on the “Vince effect” – saying uncertainty remains as to whether the new business secretary Vincent Cable will break up many of the bigger banks and impose far tougher limits on how these firms renumerate their staff. While uncertainty remains, share prices may be vulnerable.
But he added: “Many FTSE companies, including the banks, have performed better than analysts’ expectations. Many private firms cut jobs viciously at the start of the downturn, but over the past six months are now starting to hire people again and expand. But this is in contrast to the nasty situation that many in the public sector are now facing.”
Mr Wilson added: “Equities remain good value on a global basis, and the UK is no different. Furthermore, the UK has a good and diverse blend of global companies and should sterling prove weak as the economy struggles then this may well benefit the market as foreign earnings are then boosted in sterling terms and the UK market would appear more attractive to international investors.”