In the past, the outcomes of general elections in developed economies have tended to have a limited effect on market sentiment and behaviour. But this election year in the UK, there is greater uncertainty than usual as to which party will win. There is also greater uncertainty as to how the economy will fare and how successful either party will be in tackling the central economic issue - the ballooning government deficit.

'A hung parliament could shake investor confidence if there is no clear leadership'

If there is one thing markets don't like, it is uncertainty. So a hung parliament, for example, could shake investor confidence if there is no clear leadership and another election is called. This could lead to a further period in which borrowing continues to mount and bond market investors are not given details of how the deficit is to be reduced. This in turn could drive up gilt yields, making borrowing more expensive.

Once a government has been chosen, it will need to demonstrate to debt holders that it has the political will to execute measures which will inevitably involve a degree of pain for the public sector and taxpayers.

If the incoming government fails to grapple with the deficit issue or conversely, slashes spending too aggressively before the recovery has taken hold, then we could see the country slide back into recession and the market fall. This would mirror events in the early 1980s when the then Prime Minister, Margaret Thatcher, had to make sweeping spending cuts and put up indirect taxes even as she reduced income tax.

There is a school of thought which believes that were it not for the British victory in the Falklands War, Mrs Thatcher would not have stayed in office long enough to see such difficult financial decisions bear the fruit that they did.

This time, there is additional pressure on the market economy from regulators, both national and international. Having previously failed to act, regulators are now determined to try and stop banks from taking the kind of excessive debt-fuelled risk that caused the financial crisis and subsequent global slowdown. But if the new measures are too stringent, they could damage the banking system and reduce lending even further, restricting economic growth.

Given these factors, the market is likely to take more account of this election than most. That said, we live in a global economy and global factors will remain a significant influence on investor sentiment. Moreover, many of the UK's largest blue-chip companies generate most of their earnings overseas and so are little affected by domestic politics.

So where are markets headed? As ever, no one can be entirely sure, but our sense is that this may be a year in which traditional maxims such as "sell in May and go away" are fulfilled. On the political front, May is likely to be the election month which could be swiftly followed by an emergency budget or the upheaval alluded to above.

More importantly, there are already signs of consolidation in equity markets after last year's strong gains. These may well indicate that, after the initial euphoria over the avoidance of a global depression and the benefits of fiscal stimulus packages, investors are starting to price in the difficult economic environment ahead of us.

While economies have been bolstered by low interest rates and stimulus packages, given the vast accumulation of debt by consumers and governments, growth in the West is likely to remain anaemic for some time.

For example, the UK's Public Sector Net debt as a percentage of GDP is expected to hit 56% in 2009-2010 (up from 44% in 2008-2009). It is then predicted to reach 65% in 2010-2011 and be over 70% for four years after that. This borrowing will have to be repaid over time through spending cuts and tax increases, weighing on consumers' ability to repay their own debts.

UK inflation has begun to pick up in early 2010 as a result of VAT rises and higher food and oil prices. However, this increase is likely to be temporary as there is still considerable excess capacity in the economy, which will constrain prices and wages for some time. We believe substantial rises in interest rates are, therefore, unlikely for several years.

That is good news for the price of assets such as equities and corporate bonds over the medium term. Nonetheless, investors should be prepared for a 'hippo' market - i.e. where indices trade within a broad range over time with strong rallies and setbacks in-between - similar to what we have seen in the past decade. Despite the benign environment of low interest rates and inflation, I would not expect equities to break above their long-term highs for some time as economic growth will not be sufficient to support the kind of earnings growth we saw in the 1980s and 1990s.

But this should be positive for stock pickers who aim to consistently outperform their benchmarks. In a low growth environment, gains from equities are likely to come over time from dividend growth while, after a period of strong price rises, returns from corporate bonds are more likely to come from income rather than capital gains. This may encourage some investors to shift from bonds into income funds.

While macro factors will continue to dominate market sentiment, there is still room for political change in the world's largest economies to have an impact. This was recently demonstrated in the US, by the surprise election of a Republican in a former Democratic stronghold in January. The election result hurt the Obama administration which responded with a crackdown on banks, knocking financial stocks. It just shows that whatever investors' expectations are, a week in politics can sometimes be long enough to change them.