Will Hung Parliament Sting UK ETF?

by on May 3, 2010 | ETFs Mentioned:

Depending on the time, place, and specific circumstances, different issues generally come to the forefront during election season. In certain years, environmental campaigns receive particular attention. In others, dominant issues can include tax cuts and immigration reform get top billing. But in democratic elections around the world over the last two years, one issue has consistently trumped all others: the economy. This week’s election in the United Kingdom will be no different, with three main party leaders furiously traveling the country to promote their plans to stabilize a still-fragile recovery effort.

Some elections are foregone conclusions, with the ultimate outcome having little impact on the national economy (last week’s vote in Austria, which saw incumbent Heinz Fischer claim a landslide victory, is a good recent example). But when the races are close and the results uncertain, stock markets can go on a wild ride. Last year the election of the generally pro-business Indian National Congress sent India’s benchmark stock market higher by a whopping 25% in a single session. In September, an alliance between two parties signaling support of free markets in Germany sent the iShares MSCI Germany ETF (EWG) surging.

In the United Kingdom, the political picture is as cloudy as ever, with little chance of any clarity before the final results are announced. Depending on how the situation in London plays out, British equity markets could be in for a rocky ride (see Three ETFs To Watch This Week). The major turn in this year’s elections came during the first of three televised debates, when Nick Clegg delivered an impressive performance that catapulted his Liberal Democrat party into a tight three-way race that some hope will challenge the traditional two-party system. With the election less than 72 hours away, the Conservative party was capturing about 33% of the vote, with the Labour Party and Liberal Democrats each garnering 28%.

As candidates race furiously towards the finish line, a “hung parliament” in which no party achieves a majority looks very possible. And some investors believe that’s very bad news for British equities.

If no party takes a majority of the seats in the House of Commons, Clegg and his party would likely become “kingmakers,” empowered to align themselves with either party to create a majority vote on various issues. While that arrangement might allow for progress to be made on certain issues, the UK is currently facing a number of critical tasks, not the least of which is how to handle mounting national debt. “Hung parliaments are like mine fields chock full of unexploded mines,” writes David Schwartz. “I fear shares could easily drop by a double-digit amount at the first whiff of conflict between opposing parties about how to attack the debt problem.”

While much of the attention on European equities has focused on Greece (and more recently Spain), the United Kingdom economy has struggled in 2010 as worries over rising debt and unemployment drag on markets. A divided London could make addressing these nagging issues problematic, and threatens to deadlock  parliament at an inopportune time.

Britain ETF In Focus

Turmoil in the UK would have a significant impact on the global equity markets, but some ETFs would be affected far more than others. The iShares MSCI United Kingdom Index Fund (EWU) offers targeted exposure to the UK economy by seeking to replicate the MSCI United Kingdom Index. EWU is currently down slightly on the year, as uncertainty over Thursday’s elections have weighed on stocks. Investors are debating whether the risk of a hung parliament has been fully priced into asset prices, with some pointing to historical election results as cause for concern. In 1974 British stocks sank nearly 40% in the six months following a hung parliament. While a repeat of that freefall seems extremely unlikely, investors worry that divided parliament will be bad for markets, and will further complicate Britain’s cloudy economic picture.

For more actionable ETF ideas, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.