Andrew Bell, the Chief Executive of Witan Investment Trust in London, graciously agreed to allow me to share his insights on Brexit with our readers:
Yesterday’s result was not widely anticipated, to say the least, and is a reminder of Goodhart’s law (which, paraphrased, said that once a measure starts to be watched or targeted it stops being a good measure). The assumption that the bookies always get it right will have taken a knock, given that the polls were indicating a near dead heat, consistent with the result, while the Bookies yesterday had 5/1 against an exit vote.
There is little point in investors taking precipitate portfolio action, as selling what you wish you had sold yesterday is rarely the right reaction in markets dominated by position-adjustment and recalibration of expectations. Better to wait for opportunities to be revealed by volatility than to be part of it.
It is likely to be a greater potential risk for the UK economy than the UK stock market, given the preponderance of overseas earnings (which will benefit from a weaker pound) in the market mix.
The fall in sterling will provide a boost for UK tourism, for exporters and those who compete with imports. However, there is a risk that Companies will invest less in new UK facilities, certainly in the short-term, and the longer-term prospects will depend on the nature of the trade access deal that the UK can negotiate with Europe. The other side of the (weaker pound) coin is that domestic living standards will be squeezed owing to increased costs of imported goods (and foreign travel). Contrary to Harold Wilson’s infamous assertion in 1967, the pound in our pockets has been devalued, possibly along with our international reputation and influence.
Sterling is an important shock-absorber for the UK. Heightened economic and political risk gives a new reason for the pound to fall today but the need to rebalance the economy (which has a structural trade deficit) at a time when the budget deficit is also being reduced meant that sterling would very possibly not have bounced far or for long on a “Remain” vote.
The key risk for our domestic equity market and for economies and markets generally is the ripple effects across Europe. With the majority of Europe’s population holding national elections over 2016-17, in many cases with populist resurgent movements making headway, does the UK vote undermine the prospects of holding the Euro together (as the UK vote raises the temptation for others to make a break for it) or does it lead to more accommodative monetary and fiscal policies to help the Mediterranean countries adjust and fill the shortfall in overall demand? A bear case for the UK’s renegotiation would be that (rather like with Greece) Europe would take a hard line to deter others. A more positive reaction would be to note the massive protest and the continent-wide anti-European truculence and take a cooperative line. The latter would be appear to be the path of enlightened self-interest but the former is more in line with past form.
This leads on to the theoretical possibility that this vote is not the end of the UK’s decision on Europe. Although this may not see much airing today, it is possible that the negative consequences of a quarrelsome UK break with Europe will prompt sufficient concessions to enable the UK government to put the question again, say with a major concession on border controls or a reduced net contribution to the EU’s coffers. This might be difficult to square with the more hard-line anti-EU Conservative MPs but recall that Boris Johnson floated the “vote out to get a better deal” idea at the start of the Neverendum campaign. So this is a possibility, even if it takes a Europe-wide crisis to generate such an agreement.
Even if events have moved in a way that makes the “second vote” a hard strategy to initiate and conclude, the same forces might lead to an amicable deal on market access, which would dilute the negative consequences of possible exclusion from the single market. This is unlikely to happen without some intervening market/economic pain but in a rational world people will strike the best deal in the circumstances, not the one they threatened when it was all to play for in the campaign.
The City is vulnerable to any quasi-protectionist measures the EU might take, for example if it insisted that trading in the Euro or in EU countries’ trade finance could only be done by entities subject to EU regulation and supervision. Again, the outcome could be very tough or a deal could be struck that accepted “equivalence” in regulation. There is clearly a risk that a number of highly paid jobs become based in Europe rather than London.This seems more of a risk for the London economy than the investment markets. Offsetting this, a less onerously regulated London and its historically adaptable culture could win business.
Scotland. Unless a cooperative deal on EU market access is secured (or a second referendum overturns the result) there is an explicit risk that the SNP will seek a second referendum on Scottish Independence, if they thought they would win. The outcome would depend on whether wanting to be “Independent within Europe” outweighed doubts over “How to balance the books given $50 oil?”. However, this is an additional factor diminishing the UK’s political influence which currently ranks beyond its economic importance.
Diminished global influence. This might not matter in the long-term scheme of things (being a logical extension of a long retreat from Empire and a path trodden long ago by Egypt, Greece, Rome, Austria, Spain and others) but it will have an effect on our negotiating leverage in the immediate term. The idea that, unshackled, we can pivot to Asia and other rapid growth markets is regrettably unpersuasive (and could be affected by our reduced economic leverage) – Germany already does this so perhaps the UK has gaps in its product offering.
Cameron. As I write, David Cameron has announced that he will remain at PM in the short-term, to provide immediate stability but will make way for a new leader in the autumn. Meanwhile the formal triggering of Article 50 (under which notice of departure from the EU is negotiated) will not take place – this will be for the new PM to initiate. Aside from the sensible objective of maintaining near-term political stability, he probably has in mind the avoidance of a Miliband-type catastrophe of an abdication forcing an untimely election on an unstable party. He clearly takes the view that staying longer to strike the best possible terms in an EU exit negotiation (or for a second vote) is not feasible, given the split in the Conservative party. Arguments against staying as PM included the difficulty of having to implement a policy with which he disagrees, in office but not in power, and the need for someone to take the blame for the failed referendum gamble, which he has.
More stimulative policy. It seems likely that the increased uncertainty, and possible actual negative consequences for growth will prompt easier economic policies world-wide. Although a purely UK shock could be shrugged off by the world economy, a Europe-wide political and economic shock would be felt globally. Monetary policy (provision of liquidity in adequate quantities at attractive cost) can stabilise financial markets and the financial system but has probably largely done its work in reducing the costs of debtservice and (with negative rates) may have become counterproductive at the margin. If the first (lengthy) phase of recovery from the 2008 financial crisis involved recapitalising the banks and having record low rates to enable a superabundance of debt to be serviced, thus preventing a collapse in demand, the next phase will need to create a source of demand (assuming that the alternative of reducing surplus capacity as a means to rebuild pricing power and inflation is not an attractive option). This might come to involve measures akin to FDR’s New Deal in the 1930s. Infrastructure spending funded by government borrowing at almost nil cost is already coming onto the agenda in Canada and Japan and is on both parties’ agendas in the US. Current fiscal policy in the UK and Europe is still focused on reducing deficits while hoping that other factors will support growth. This may be running out of road.
The immediate impact today has so far been a 3-12% fall in global equity markets, although in sterling terms the falls in overseas markets are less severe. Europe has been worst hit, with Japan also down 8%, not helped by the reflexive buying of the yen as a “refuge”.
Whether this is the start of a major or sustained correction in markets depends on whether the ripples and the shock to confidence can be contained. Europe, and how it handles itself (with a Spanish general election on Sunday) will be at the centre of this. The US economy is relatively resilient and there are few immediate consequences from the UK’s vote (bar a worry of a mood of political populism helping Mr Trump).
The risks of financial contagion appear manageable. The Central banks have had plenty of time to plan, with the Leave camp in the poll ascendancy for much of the past month, even if people did not believe it. Most parts of the banking sector are well-capitalised in contrast to 2008 and 2011.
Although many did not favour the “Brexit” arguments, I think it is quite possible that the post-vote mood will be less gloomy than the younger generation and the metropolitan intelligentsia may feel today. After all, half the electorate have got what they wanted and, as hyperbole to deter a Leave vote gives way to making the best of what has happened, the other half is unlikely to enter prolonged grieving. There will be economic costs (probably less inward investment, pressure on consumers) and benefits (from a more competitive exchange rate) and it is not clear, in isolation, which will dominate over the coming years.
The key battleground for confidence will be in Europe – will they prove better equipped and more nimble than in the 2011-12 Euro crisis? If they can sustain the gradual recovery in the region’s economy (which may mean the ECB having to use fully the measures it has put in place since Draghi’s “whatever it takes” speech in 2012) and avoid fragmentation of the Eurozone, the global ramifications will be limited in economic terms.
Posts by Dr. Edward Yardeni
© 2022 Newsmax Finance. All rights reserved.