The Rise and Fall of UK Political Uncertainty in 2022

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While the latest filibuster chatter and November’s midterm elections are hogging most political headlines in the US, there is no shortage of theater abroad—and no shortage of uncertainty. Some of it is electoral, with contests looming in France and Australia. Some relates to shaky coalition building, which may soon be reality in Italy if Prime Minister Mario Draghi gets tapped as president later this month. And some is just good old fashioned scandal and parliamentary revolt, which happens to be the situation in the UK. Yes, Prime Minister (PM) Boris Johnson is—once again—facing calls to resign over some Downing Street socializing during 2020’s lockdowns. There is even speculation a police investigation could lead to formal charges for violating lockdown rules. We won’t hazard a guess on whether Johnson’s days are numbered, but we do think this is a textbook example of how high uncertainty early in the year is likely to fade gradually into gridlock—which should be a bullish tailwind later this year.

Until this week, Johnson somehow managed to maintain plausible deniability about his knowledge of gatherings that broke the rules. Even when a picture emerged last month of him enjoying wine and cheese with staffers in the Downing Street garden in May 2020, rumbling about a “work event” held the wolves at bay. But that was before someone leaked the email from one of his senior aides inviting over 100 staffers to “make the most of the lovely weather” and “bring your own booze” on May 20, 2020, a time when normal Brits weren’t allowed to gather in groups larger than two—even outdoors. As you might expect, people are now posting videos of police breaking up gatherings the same day, along with pictures of dying relatives they weren’t allowed to visit. Labour leader Keir Starmer (who was previously caught having a tipple indoors with staffers despite a ban on indoor gatherings) is urging Johnson to resign, which isn’t new—but Scottish Conservative leader Doug Ross is also calling for his head, which is. So are several backbench Members of Parliament (MPs), a broad swath of the public and some Conservative-leaning columnists.

Yet so far, he is hanging on—in no small part due to the cabinet’s continued support. That group includes Chancellor of the Exchequer Rishi Sunak and Foreign Secretary Liz Truss, widely seen as the top two potential leadership challengers. The support of these senior Tory figures suggests they don’t yet see now as an optimal time for a challenge. But this may change, pending an official investigation by Sue Gray, a senior civil servant whose resumé includes the position of Director-General of Propriety and Ethics in the Cabinet Office.

If Johnson survives this bout, he likely isn’t in the clear, as a significant hurdle looms: a triple whammy of tax changes that, combined with ongoing inflation, many have termed a “cost of living crisis.” This April, barring a late change, the increased National Insurance Contribution (NIC, taxes to support Britain’s National Health Service) takes effect, and value-added tax (VAT) relief on food and drink will end, bringing VAT back from 12.5% to 20%. Income tax bands also start a five-year freeze in April, even as inflation erodes a big chunk (if not all) of many households’ nominal wage increases. This means thousands of households will land in higher tax brackets thanks to inflation alone, adding to their burden. Now—and this isn’t a political statement—we don’t think this is a huge negative for stocks, as markets don’t think in terms of “good” or “bad” in the absolute sense. Rather, what matters is the degree to which any development packs negative surprise power. In this case, added household costs are widely known, having been on the calendar for months. The amounts in question also aren’t huge from stocks’ vantage point, even though they are obviously negative for individual households—particularly lower-income households. Markets are just cold-hearted, rational beasts.

But there is a very good chance that, as households’ costs rise, voters’ frustration with Johnson grows, particularly considering the NIC hikes violated his campaign manifesto. This is also starting to split the cabinet, as some high-profile members have reportedly urged Johnson to cancel the tax increases to give households some relief. The more scandals weaken his political capital, the louder those calls probably get. Even if they don’t lead to actual tax relief, they could finally foment the cabinet revolt many observers think is likely this year.

However this resolves, we see a high likelihood that uncertainty stays high through the winter and early spring, then dies down once people have clarity on who will be in charge. Whether that person is Johnson, Sunak, Truss or someone else, it likely leads to more gridlock, as their main task will be to rebuild popular support for the party before the next election, due by 2024. That creates a strong incentive not to rock the boat with big legislation. If Johnson remains PM, his political capital may also be so depleted that his ability to push divisive legislation will be sapped.

In our view, stocks should therefore enjoy a two-pronged tailwind from leadership clarity and lower legislative risk as the year rolls on. That doesn’t preclude short-term volatility, especially with all the other fears plaguing sentiment right now. But holding on through short rocky patches is often necessary to reaping stocks’ long-term returns.