Investors will hate consequences of a hung parliament

POLLING DAY is still about six months away but already the battle lines are being drawn between the two main political parties. The general election will add another dimension of uncertainty to 2010, which is already shaping up to be a very volatile year for investors. <br /><br />The general election is a scheduled event so it does at least differ from the uncertainties posed by the tricky process of policy withdrawal, as global authorities bite the bullet and start removing the life support system from a still critical patient. That said, the UK&rsquo;s election is likely to be unlike any other since February 1974, which produced Britain&rsquo;s only hung parliament since the Second World War. <br /><br />Many consider the Conservative Party a virtual shoe-in and the Electoral Calculus website shows that the Tories are forecast to enjoy a majority of 66 seats &ndash; comfortable enough, one might think. Extrabet punters are predicting an even more comfortable win: the spread for the number of Conservative seats is currently at 352-357 compared to a spread of just 208-213 for Labour. <br /><br />But more recent public opinion polls have indicated that the Labour administration is beginning to close the gap between the two parties ahead of the keenly awaited Pre-Budget Report on 9 December.<br /><br />Much can happen between now and polling day, but a hung parliament in 2010 is beginning to look like more than just an outside possibility. Although the nature of the 1974 economic crisis is far removed from that of the present, investors and spread betters will no doubt pick up a number of uncomfortable similarities including financial market volatility and a currency crisis.<br /><br />So while it is always dangerous to make too many comparisons with election periods of the past, what can spread betters learn from the market&rsquo;s performance in the aftermath of the 1974 election? <br /><br />On that occasion the UK equity market underperformed its European counterparts heading into the election, doubtless working on the assumption that the result would be close, but underperformed by a further 15 per cent in the ensuing three months, once the result was known and the inevitability of the need for a further election had sunk in.<br /><strong><br />DIABOLICAL POSITION</strong><br />Investors loathe the political uncertainty associated with &ldquo;no overall control&rdquo;. They hate it all the more when aggressive policy action is required to address a diabolical fiscal position and the country&rsquo;s credit rating is at stake. Indeed, political uncertainty is just about the last thing investors want right now, given the probability of other potential threats to the status quo also occurring.<br /><br />Policy remedies to cure the country&rsquo;s economic ailments are undoubtedly going to be extremely severe. Seeing such policies through will require a steely resolve in the face of what will likely prove universal unpopularity, particularly so in the context of rising unemployment and brittle confidence levels.&nbsp; <br /><br />Most voters sell their votes to the highest bidder. But this time around they&rsquo;ll probably sell to the party they view as being the least-low bidder. Politicians understand that sentiment intuitively and policy differences ahead of the official manifesto launch dates are increasingly discernible.<br /><br /><strong>DOMESTICALLY FOCUSED<br /></strong>With the domestic environment tightening &ndash; whether that be via higher taxation or spending cuts &ndash; investors are more likely to choose countries with plenty of overseas exposure. This is likely to result in a muted impact on the FTSE 100, which already comprises plenty of multinationals. This will not be the case for the more domestically focused FTSE 250 and Small Cap indices, which could see sharp moves as fiscal tightening ensues after the election. <br /><br />Charles Stanley already maintains a preference for larger companies over their smaller counterparts and a strong preference for a quality growth investment style over cyclicals and momentum strategies.&nbsp; Interestingly, the stock market&rsquo;s strength over the past nine months has resulted in pronounced price/earnings disparity between the various styles while dividend payouts look just as, if not more, reliable going forward.<br /><br />Whether the government bond market can maintain its prolonged bull run in the face of high and rising macro economic uncertainty remains very much to be seen. Its safe haven status might well be called into question were the financial crisis to flare up again, just as it has in Dubai. <br /><br />Spread betters will be looking for opportunity but they should also be looking for means to protect other investments they may have. Next year even the most optimistic investor has to learn how to hedge against the very considerable risk that all might not be quite as well as the stock market&rsquo;s blistering performance over 2009 might have us believe.&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; <br />&nbsp;&nbsp; <br />Jeremy Batstone-Carr is director of private client research and investment strategy at stockbroking firm Charles Stanley.