David Prosser: Should it be the economy, stupid?

Outlook The notion that a hung parliament would be bad news for sterling – as political uncertainty might delay the day of reckoning for the deficit and thus precipitate a credit downgrade – seems to have moved from theory to fact during the run-up to the election being called, despite the counter-argument.

This is that with the Liberal Democrats, who have been more open about their plans for cuts than either Labour or the Conservatives, holding the balance of power, a credible road map for dealing with the debt might actually emerge more, rather than less, quickly in the event that neither of the two big parties secures an overall majority.

The question is how long it takes to form a government in such circumstances and the strength of the coalition once established. The longer the negotiations take, and the greater the perceived likelihood of there being a second election in a relatively short space of time, the greater the uncertainty and, thus, the greater the volatility in the gilt and currency markets. Either way, however, we should be careful about attaching too much weight to the outcome of the election, at least in the context of what it might mean for the markets.

Government action on borrowing is certainly important to Britain's hopes of reducing borrowing in the years ahead, but just as crucial is the speed at which the economy grows. While Messrs Brown, Cameron and Clegg have a role in determining that, it will be secondary to the importance of how the global economy performs.

A fascinating piece of research from Goldman Sachs illustrates just how little the election outcome might really matter to the markets. It charts the performance of the UK stock market, relative to US equities, in the months following each of the last 10 general elections, going back 40 years. What it shows is that UK equities have moved broadly in line with the US – that is, the poll result has had no discernible effect on the market – after eight out of 10 of those elections.

The exceptions are interesting. The market fell 16 per cent during the month following the first election of 1974, which produced a hung Parliament. That might be worrying given the read across to today, though it is worth remembering that Britain was at that time in the middle of an oil crisis induced by a recession, which may have been more important than worries about political uncertainty.

The second exception was 1992, when the Tory victory was to some extent a surprise: the market bounced strongly in the month after the poll. Now, you could read that as evidence for the accepted wisdom that the City is predisposed towards the Conservatives, but a more likely explanation was that the bounce reflected relief that a hung Parliament did not come to pass as many had expected. As with gilts and currencies then, it seems that stock markets are not so keen on uncertainty, at least in the very short term, but relatively unmoved about who wins elections. This is to be expected: the stock market is dominated by FTSE 100 companies whose business activities are, to a greater or lesser extent, global. For most of them, difficulties in the UK are an irritant rather than a threat to their existence.

Smaller companies, on the other hand, are much more likely to be exposed to the UK's economic cycle. The stockbroker Brewin Dolphin points out that in recent months the small caps have underperformed their larger brethren, and wonders whether this is because the market is pricing in a Tory victory and tougher action on the deficit: that might be a risk factor for companies that are dependent on the UK.

The small caps aside, however, Goldman's evidence is that investors, rightly or wrongly, have not, in recent times, been too concerned about who wins elections in Britain. And even in the cases of 1974 and 1992, Goldman reports that the short-term price movements had begun to flatten out within three months of polling day.

The economy will be the dominating issue in this election campaign – as it should be given the turmoil we have just been through. However, the lesson of history, despite all the hysterical warnings about runs on the pound and stock market crashes, is that who we choose to run the country may not, in the end, make as much difference to our economic wellbeing as we imagine. Or at least that is what the markets think.