Why The FTSE 100 Could Be On The Edge Of A Cliff

With the General Election now being just two weeks away, it is becoming increasingly likely that the result will see no one party gain a majority. This, then, is a similar situation to that which we found ourselves in five years ago, when the Conservatives and Liberal Democrats together formed a coalition that has lasted the course. Now, though, the outcome of a hung parliament may not be so straightforward and, importantly for investors, could cause the FTSE 100 to tumble.

Short Term Problems

The difference this time around is that there are many more ‘cooks in the kitchen’. While in 2010 only the Liberal Democrats held the balance of power, this time around the SNP and, potentially, UKIP could also act as kingmakers. This in itself is likely to make the negotiations regarding who forms a government much more difficult, as there could be two sets of two or more parties that believes it has the ability to deliver on an agenda. And, with the SNP being a Scotland-focused party, this could cause additional uncertainty in the financial markets and lead investor sentiment to decline in the short run, as doubts surrounding the Union once again surface. Overall, then, the likely impact on the FTSE 100 from a hung parliament is likely to be negative in the short run.

Longer Term Problems

With Labour ruling out a formal coalition with the SNP and the Conservatives and SNP also discarding the idea of joining forces, the only feasible coalition is either a Con-Lib coalition, or a Lab-Lib coalition. However, with the Liberal Democrat vote slipping back, it appears as though neither of these pairings will be enough to gain the 326 seats needed to form a majority. And, even including UKIP in the Con-Lib pairing does not seem to be enough, either.

Therefore, the most likely outcome is a minority government. This could cause major problems for the UK economy and for the FTSE 100. In fact, history does not paint a pretty picture of such a scenario, with the last time the UK had a minority government being the 1970s under James Callaghan. It can be summed up as a couple of years of pain, with the UK economy lagging extremely far behind the rest of Europe, followed by a winter of discontent before Margaret Thatcher won power in 1979.

While the UK economy is in much better shape today than it was in the mid-1970s, uncertainty can quickly lead to fear, which in turn can cause panic. The big difference today versus the 1970s is the mobility of capital, with investors able to sell up and move to a different region at the click of a button. As such, the UK economy and FTSE 100’s current purple patch could come to an abrupt end if a minority government is unable to govern effectively.

Looking Ahead

Although all investors are hopeful and would like to see the FTSE 100 rise significantly over the coming months and years, the reality is that we could be in for a very challenging period. The FTSE 100 is unlikely to move much higher unless there is certainty regarding the political climate and, with the polls suggesting that a minority government and second election before 2020 is the most likely outcome, the FTSE 100 may be set to endure a more difficult period that many investors currently expect.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.