U.K. stocks to be wary of with election just weeks away

By Sara Sjolin, MarketWatch

LONDON (MarketWatch) — The U.K. general election is turning into a thriller for politicians and stock investors alike, as the lack of a clear favorite makes it trickier to take a position.

With May 7 approaching fast, polls reflect a neck-and-neck race between the Conservative Party, which leads the ruling coalition government in partnership with the Liberal Democrats, and the Labour Party, creating lots of anxiety about the structure of the future government and its potential impact on U.K. businesses and financial markets.

On top of this, investors also have to worry about the prospect of a 2017 referendum on whether the U.K. should leave the European Union.

Several investment banks have urged investors to remain underweight U.K. equities until the political uncertainty has passed. Instead, they suggest investors should jump into eurozone assets, which are benefiting from a weak euro and aggressive monetary easing from the European Central Bank.

However, some sectors are likely to be affected more than others, and fund managers asked by MarketWatch pointed specifically to utility, banking and gaming as industries that would be better to avoid.

Here’s a rundown of what to expect in the run-up to the election and in its aftermath.

In the run-up

Political uncertainty is only likely to increase as we get closer to the ballot, and you’re better off staying away from the U.K. stock market until the result, analysts said.

While the U.K. economy is doing far better than most of its European peers, the British stock market is having a rough time keeping up with the stellar gains seen on the Continent. The FTSE 100 index /zigman2/quotes/210598409/delayed UK:UKX +0.91%  is only up 4.6% year-to-date, whereas the pan-European Stoxx Europe 600 index /zigman2/quotes/210599654/delayed XX:SXXP +0.70%  has logged a 16% rally.

This is partly due to the European Central Bank’s quantitative-easing program, which has pumped up European stocks. But it’s also because fund managers are wary of piling into U.K. stocks before knowing who will hold the keys to 10 Downing Street after the election.

However, if you’re already holding U.K. stocks, there’s no reason to run for the hills, according to Neil Veitch, fund manager of the SVM UK Opportunities Fund.

“If I was holding U.K. stocks, as we do, I would hold on to and retain your positions, because the U.K. equity market in a global context looks relatively attractive,” he said.

Leader of the opposition Labour Party Ed Miliband arrives to launch their general election campaign in east London last month.

If a Labour-led government takes power

One concern is a potential switch to a Labour-led coalition. Traditionally, a Labour government is seen as less business-friendly than its Conservative counterpart, as it’s expected to bring in higher taxes, more regulation and greater public spending.

Particularly for this election, there are three sectors that could be slammed extra-hard in the event of a government change, which are mentioned on the next slides.

Utility firms like Centrica could be impacted by a Labour government

If a Labour-led government takes power

Utilities: Once loved for their steady returns, but now a thorn in the side of many fund managers. The sector is what Chris Rodgers, senior U.K. fund manager at Sanlam FOUR, describes as a “political football” and has been under strain since Labour leader Ed Miliband in 2013 vowed to force utility companies to freeze prices if he was elected. Reducing energy bills is also a key part of Miliband’s campaign to fight what he calls the “cost-of-living crisis.”

Among U.K. companies likely to be affected are Centrica /zigman2/quotes/205228367/delayed UK:CNA -0.78% , SSE /zigman2/quotes/204546319/delayed UK:SSE +0.41% and United Utilities .

Major U.K. banks could be at risk of break-ups

If a Labour-led government takes power

Banks: The financial sector could find itself smacked with tighter regulation and tougher taxation under a Labour-led government, which would hurt banks’ bottom lines, the fund managers said.

“It’s an easy target. Many people still feel the banks haven’t been hurt enough after the crisis,” Rodgers said.

There’s also a risk that a Labour-led government will break-up the biggest U.K. banks in a bid to improve customer service and increase lending to small businesses. The banks at risk of this would be Lloyds Banking Group /zigman2/quotes/202285510/delayed UK:LLOY +0.29%   /zigman2/quotes/200709414/composite LYG +2.04% , Royal Bank of Scotland Group  , Barclays /zigman2/quotes/208409333/delayed UK:BARC -0.32%   /zigman2/quotes/206581728/composite BCS +0.17%  and HSBC /zigman2/quotes/203901799/delayed UK:HSBA +0.46%   /zigman2/quotes/208272822/composite HSBC +1.00%   /zigman2/quotes/202687335/delayed HK:5 +0.82% .

The gambling industry may be hit with new levies under a Labour government

If a Labour-led government takes power

Gambling: The gambling industry has had a solid run, but analysts fear an Ed Miliband-led coalition could hit it with levies aimed at increasing tax revenues. Rodgers revealed that he recently sold shares of William Hill  and Betfair  — stocks that had performed really well in his portfolio — out of fear that Labour will place additional taxes on gambling stocks.

“They are some of the best-managed companies in the U.K. gaming sector, but we thought it prudent to sell those ahead of any potential [political] change,” he said.

Retailers like Sainsbury’s are sensitive to changes in the minimum wage

If a Labour-led government takes power

Wage-sensitive stocks : Labour has vowed to increase the national minimum wage to 8 pounds ($11.83) an hour by 2020, an increase of 23% from the current £6.50. Simon McGarry, head of U.K. equity research at Canaccord Genuity Wealth Management, said retailers and the leisure sector would likely take a hit from that, as their workers are traditionally not high paid. This will make them more sensitive to a jump in the minimum wage.

According to McGarry’s calculations, baked-goods chain Greggs PLC /zigman2/quotes/205743109/delayed UK:GRG -0.66%  is the most wage-sensitive U.K. retailer. A 10% rise in salaries across Greggs’s entire group would be expected to prompt a 52% drop in operating profit, he noted. Other retailers on his watch list are Tesco PLC /zigman2/quotes/203761082/delayed UK:TSCO +1.56%   /zigman2/quotes/207784767/composite TSCDY -1.04% , Home Retail Group PLC /zigman2/quotes/221810778/delayed UK:HOME +0.40% , Wm. Morrison Supermarkets PLC  and J Sainsbury PLC /zigman2/quotes/206038250/delayed UK:SBRY +1.35% .

Investors are worried what will happen if Britain gets to vote on it’s EU membership

If a Conservative-led government takes power

“Brexit” fears: This time, a Tory government might not be as business-friendly as usual. Current Prime Minister David Cameron has pledged to put the U.K.’s EU membership up for a referendum in 2017 if his Conservative Party wins the election — and that has put the country’s future relationship with its main trading partner into doubt.

And if there’s something the stock markets don’t like, it’s uncertainty. Economists have been scrambling to calculate the broader economic impact of potential “Brexit”, shorthand for a British exit from the EU.

Although there are lots of unknowables at this point, there’s a “tendency for existing research to reach the conclusion that the U.K.’s exit from the EU would be a negative for GDP,” said analysts at RBC Capital Markets.

That would hit many sectors of the U.K. stock market, but the highly GDP-correlated banking industry in particular would feel the squeeze, they said.

There’s no silver lining for the pound when it comes to the election outcome

Whoever wins

Sterling blues: For the pound /zigman2/quotes/210561263/realtime/sampled GBPUSD -0.2413% , it looks like a lose-lose, whatever the outcome of the election.

If Labour takes charge, that’s seen as translating into looser fiscal policy, which would be bad for sterling. But if the Conservatives form a government, that increases the likelihood of a “Brexit”, which would also be a negative for the pound.

“The only clearly [pound]-positive scenario would be a limited swing in voting intentions toward the Conservatives,” the RBC analysts said. “Even this could turn quickly [pound]-negative, as we estimate that the implied probability of a growth-sapping EU exit could jump from 15% currently to close to 50% under a Conservative majority government.”

A slide in sterling would be good news for the U.K.’s exporters, as their goods would become more attractive to holders of other currencies. Companies with lots of sales in the U.S. could get a boost if a weaker pound collides with a strong demand for dollars. Within the FTSE 100, such companies include Ashtead Group PLC /zigman2/quotes/200232063/delayed UK:AHT +0.81% , Shire PLC , Pearson PLC /zigman2/quotes/204954587/delayed UK:PSON +1.92%  and National Grid PLC , according to FactSet GeoRev.