By Tom Elliott, deVere Group’s International Investment Strategist
Investors should above all remain calm. Today’s Brexit vote does not herald the end of the world, and in all probability the sell-off in risk assets and sterling that we have seen this morning will soon be partially reversed as the U.K government and euro zone leaders make calming statements about the need to work closely to achieve a harmonious break up.
The leadership of the Brexit campaign team that probably lead a new U.K government do not, at heart, believe in the anti-immigration, ‘Little Englander’ rhetoric that many of their supporters expressed. Therefore, while a new government will be more right wing it is unlikely to be protectionist or anti-capitalist in flavour. I suspect the U.K has not in fact left the E.U, but will acquire a quasi-membership status, similar to Norway or Switzerland.
The fall in sterling will result in higher U.K inflation, credit conditions are likely to tighten as inter-bank lending rates reflect an increased political risk premium, aggravating delays we will see in decision making over new investments in the economy. A rise in the cost of commercial borrowing will lead to a rise in household mortgage interest rates, putting downward pressure on an expensive U.K housing market.
However, sterling’s fall will help counter some of the above by providing a boost to exports and provide some help to domestic-orientated firms as they compete against imports.
JPMorgan today forecast U.K growth now falling by 1% or so from where it would have been over the next 18 months, to around 1%. A mild recession is possible.
The Bank of England will leave interest rate policy alone until August at the earliest, as it waits to see how inflation and growth are affected by the Brexit vote. We may see an interest rate cut, and/or a resumption of quantitative easing policies if need be. Governor Mark Carney has today reassured markets that U.K banks have 10 times more capital than they did in 2008 (and so can withstand shocks better), and has promised to make £250 bn of immediate liquidity available to banks should a run on confidence emerge.
The E.U economy will also be hurt, with growth negatively affected, on account of the U.K being the second largest economy in the E.U and the Brexit campaign has been followed closely by other euro-sceptic parties. The impact will occur through three channels: heightened political uncertainty over the E.U project in general, and specifically the ability of the euro zone to build the political and fiscal union needed to created a fully functioning euro currency. Second, the improved price competitiveness of British exports within E.U markets and around the world will weaken the profitability of other E.U companies, and third, weaker demand in the U.K for E.U goods due to higher prices and a weaker U.K economy.
If you are already invested broadly across asset classes and regions (ie, have a global multi-asset portfolio), you should DO ABSOLUTELY NOTHING. There is too much uncertainty around Brexit, and other global issues, to be able to take strong bets on a region, asset class or even a currency. If you do not have such a portfolio, but perhaps remain with a strong home bias, then take action.
Avoid the temptation to bet against sterling, by hedging U.K exposure back into USD for example. Much of the damage to the pound may already be priced in. A hedged position against sterling will mean you miss out if sterling recovers, getting only the local currency return and not any currency appreciation effect.
A sudden risk-off environment often over-shoots, as investors follow each other herd-like. Speculative positions may become attractive in U.K credit, small and mid-cap U.K stocks, euro zone exporters and sterling. But these should comprise a small portion of the overall portfolio.
Brexit is unhelpful for the London and South East property market. Mortgage costs are likely to rise, while the prospect of fewer immigrants will reduce population growth forecasts.
Politics – A dis-United kingdom
The vote for Brexit did not come about through a diligent study of the country’s relationship with the E.U by the leaders of either side of the campaign, or by the popular press. It came down to an anti-elitist, and at times racist, kick against what was perceived to be an unresponsive governing domestic and global elite. It was a cry against modernity, globalisation and liberal values that is echoed in the U.S by supporters of Donald Trump and elsewhere in the E.U by populist political movements.
Prime Minister David Cameron has announced his decision to step down before the October Conservative Party conference. As he should, since he called the referendum in a bid to out-play a small but vocal euro-sceptic wing in his own party. His likely successor is either Boris Johnson (former Mayor of London) or Michael Gove (current justice minister). It is possible that, on taking power, they will call a general election to win a mandate for a more right-wing, populist agenda.
It should be remembered that neither Johnson or Gove, the leaders of the Brexit campaign, actually come from the anti-immigration, ‘Little Englander’, tradition that drove many of those who voted to leave the E.U. They are themselves very much part of an establishment elite. They want less interference from the E.U, to allow Britain to trade more globally and be more inter-connected with emerging economies etc. The disconnect between the Brexit’s leadership and its support base may create problems in the future, but I expect the free-market, globalisation wing to trump populist pressure groups thanks to obliging newspapers.
The Scottish National Party looks set to demand a second independence referendum, on the grounds that Scotland voted overwhelmingly to Remain. In Northern Ireland, the vote split sadly across sectarian lines and Sein Fein have spoken of the need for a referendum there in order to join Northern Ireland with the Republic of Ireland.
In terms of U.K foreign policy, it is probably as big an act of self-harm as the 1956 Suez crisis as we lose a voice in E.U policy. Thanks, David.
U.K to remain a quasi-E.U member?
However, it is not in the E.U’s interest to make the separation protracted or overly-painful for the U.K when the exit provisions of Article 50 of the membership treaty are debated. Such a policy would encourage a weak pound (which will enable U.K exporters to compete better against rival companies in the euro zone area), distract it from the multiple other crisis that are on its plate (Greek debt repayment, migrants, and weak economic growth that negative ECB rates seem incapable of curing), and it would be seen as proof to euro-sceptics elsewhere in the E.U that national sovereignty has truly been captured by a bullying E.U.
I expect a state of quasi-membership of the E.U to result, similar to the status of Norway or Switzerland. This will mean the new U.K government swallowing its pride and having to reverse several promises made to Brexit supporters. It will have to ‘pay to play’ in the single market (ie, a membership fee of some type), and have to accept in principle free movement of people within the E.U. Both of which currently apply to Norway and Switzerland.
The new U.K government and sections of the press will dress this up as a victory, because neither will relish being forced into the WTO Most Favoured Nation Treaty arrangement whereby a non-negotiable range of export and import tariffs will be imposed on the U.K and her trading partners in relation to British trade.