Investors may face rough ride if Canadian election leads to political instability

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By Euan Rocha and Alastair Sharp

TORONTO, Oct (HKSE: 3366-OL.HK - news) 19 (Reuters) - Given there is a good chance that Monday's Canadian federal election will not give one party control of the country's parliament, investors may want to brace for a period of political instability that could dent Canadian financial markets. The already weakened Canadian dollar could be most vulnerable to a further drop, market participants warned.

Most recent polls have been suggesting the most likely outcome is a center-left Liberal minority government, with a lesser possibility that the ruling Conservatives will be in a position to form a minority government. Either of them would need the support of another party to govern

The Liberals and left-leaning New Democratic Party (NDP) have telegraphed that they would not support Conservative Prime Minister Stephen Harper if he formed a minority administration. Under that scenario, they could bring down such a government and either offer to form an alternative minority government or trigger a new election.

The Liberals have said they will not go into a formal coalition with the NDP, though there is always the possibility that stance could change once the votes are in.

"What we could see is pressure on the currency more than anything else," said John Stephenson, head of Stephenson & Co Capital Management, noting it would be especially hard for a minority Conservative administration to govern.

Liberal leader Justin Trudeau has pledged to run budget deficits to fund infrastructure spending, which could boost the stocks of engineering, construction and equipment companies, though it may take a toll on government bond prices in the near-term. Both the Conservatives and the NDP have stressed they will balance the budget.

Below is summary of how some fund managers, corporate executives, analysts and currency strategists see markets reacting under a range of scenarios:

LIBERAL MAJORITY GOVERNMENT:

Among the companies who would feed off such infrastructure spending are SNC-Lavalin Group, Stantec Inc (NYSE: STN - news) , WSP Global Inc (Toronto: WSP.TO - news) , Aecon Group Inc (Other OTC: AEGXF - news) and Toromont Industries Ltd.

Canaccord Genuity (Other OTC: CCORF - news) analysts say the Liberals' deficit spending plan may weaken the Canadian dollar and government bond prices in the near-term. But they believe the resulting rise in yields could boost investment returns for insurers like Manulife Financial Corp and Sun Life Financial (Toronto: SLF-PC.TO - news) .

To be sure, some analysts believe the Liberals' deficit plan could support the Canadian dollar longer-term. Nomura noted the fiscal stimulus would reduce the need for further interest rate cuts by the Bank of Canada, the nation's central bank. Two rate cuts this year and the weakness in oil prices pushed the commodity-driven currency to 11-year lows in September.

Any gains from the infrastructure spending could be at least partially offset for some companies by the Liberals' plan to give the environmental review process "more teeth," which could slow development of new oil sands, pipeline, liquefied natural gas and mining projects.

Finally, the party's plan to put government money behind technology start-ups and invest in areas like clean technology could benefit companies in those sectors.

LIBERAL MINORITY GOVERNMENT:

This scenario is also seen providing political stability that would be welcomed by markets, Nomura analysts say.

Because they sit beside one another on the political spectrum, many think the NDP could be convinced to support a Liberal minority administration on many questions but they would likely demand a price.

This scenario could raise questions around government backing for TransCanada Corp's Keystone XL pipeline. The Liberals have come out in support of the project, while the NDP have opposed it.

A Liberal-NDP combine would likely be negative for energy companies given that both are in favor of tighter environmental and carbon emission regulations.

CONSERVATIVE MINORITY GOVERNMENT:

This is widely viewed as the most unstable possible outcome given the high likelihood that such a government could be quickly toppled by the Liberals and the NDP, and a new election may be called.

Many think this could weaken the Canadian dollar and government bonds in the near term as investors would likely hate an extended period of uncertainty, especially given the weak state of the Canadian economy, which suffered two successive quarters of negative growth in the first half of the year - for many the technical definition of a recession.

"This scenario may take some weeks to unfold and it would be some time before stability returned," said Nomura analyst Charles St-Arnaud.

CONSERVATIVE MAJORITY GOVERNMENT:

A Conservative majority is seen by Bay Street - Canada's financial hub - as positive for energy companies. The party backs pipelines that would help get crude produced from oil sands to global markets and likely narrow the discount to U.S (Other OTC: UBGXF - news) . crude and global oil prices.

Natixis (Paris: FR0000120685 - news) analysts see a Conservative victory leading to lower corporate and personal taxes, which could attract foreign capital, especially in the manufacturing sector.

"Bay Street's preference is a conservative win as it maintains the status quo. Markets hate uncertainty," said Stephenson, of Stephenson & Co.

NDP MAJORITY GOVERNMENT:

This is highly unlikely given the NDP is trailing the Liberals and the Conservatives in polls, and has been losing support in recent weeks.

Canaccord analysts say an NDP majority government "would be the most concerning scenario for energy stocks with the most affected being the senior and integrated E&Ps (exploration and production companies) and oil sands."

Canada's main stock index dropped about 1 percent in May when the NDP's victory in oil-rich Alberta's provincial election hit energy shares.

A federal NDP victory could also hurt the broader Canadian stock market given the party's plans to raise corporate taxes on large companies.

"If the NDP wins we would see a visceral reaction (from the markets)," said RBC Capital Markets' Managing Director Paul Hand.

Canaccord said the party's opposition to pipelines could also lead to more oil-by-rail traffic, helping shares of Canadian National Railway and Canadian Pacific Railway .

NDP MINORITY GOVERNMENT:

Also unlikely scenario. Given it would only be able to govern effectively with Liberal support, the NDP's more radical policies would likely be watered down. This outcome would likely to similar to a minority Liberal administration.

(Additional reporting by John Tilak and Solarina Ho in Toronto; Editing by Jeffrey Hodgson and Martin Howell)