GOING ALONE UK TO LEAVE THE EUROPEAN UNION - 1
GOING ALONE UK TO LEAVE THE EUROPEAN UNION - Introduction 3 More questions than answers 4 What happened / Market reaction 5 Outlook 6 Politics is a growing factor 7 Disclaimer The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This article is not advice to invest, or to use any of our services. 2016 The content of this guide is copyright protected and nothing may be copied out of this guide without credit and a link back to www.expatpensionreview.com 2
Introduction Following an intense, often messy and in parts tragic campaign, the UK has voted to leave the European Union. Risk assets and the currency have reacted negatively and it now seems we ll enter an extended period of uncertainty both for the UK and the European Union (EU) as the details of the exit are worked out. In the grand scheme of things, the near-term economic impact is likely to be limited, but there is a risk that the shock of the result triggers wider pent-up concerns around more substantive factors. After months of discussion, intense campaigning and tinged by the tragic death of MP Jo Cox, the British people have gone to the polls for the first time in more than 40 years to decide on the nation s future in Europe. With a vote of 52% the electorate has instructed the Government to begin the process of negotiating an exit from the EU. With this widely held to be a one-way path, there is every reason to think this process will be protracted and difficult. On purely economic grounds, many will want as orderly and amicable a process as possible. However, with a number of polls on the continent showing increasing dissatisfaction with the EU and growing separatist sentiment, there is a very strong risk that the politics overrides the economic and investment case. In such a scenario, the incentive for EU politicians would seem to be to make any exit as painful as possible to quell domestic factions which could lead to further disintegration of the trading bloc. Talk to our team Get in touch for help and advice: 0121 696 4616 enquiry@expatsavingsteam.com 3
More questions than answers UK voters have spoken and, contrary to the guidance of most of the political class, have voted to leave the European Union. This should now trigger a formal exit process, but given the constitutional challenges, lack of precedent and relatively close result, this will not be straightforward. The government may choose to delay formal notification until the Conservative party leadership situation is resolved and until its policy ducks are in a row. There is even a chance that the UK could remain in the EU the referendum is not legally binding and Parliament must vote to repeal the 1972 European Communities Act. Also, despite their rhetoric in the run up to the vote, European leaders may well explore new ways to keep the UK in the EU. Either way, following initial disruption to financial markets, there will be a period of reflection as all parties come to terms with the result. It should be remembered that until it secedes, the UK is a member of the EU and will continue to benefit from the single market while there will be uncertainty, the full economic impact of this vote will not be felt for some time. In the meantime, political uncertainties, particularly now that David Cameron has indicated that he will resign as prime minister, will continue to impact on financial markets. The full economic impact of this vote will not be felt for some time 4
What happened Whilst polling data had shown for some time that the result would be close, a shift in favour of the Remain camp in the last few days meant many were caught by surprise by final result, reflected in the market reaction. At the same time, although betting odds had been consistently tilted heavily towards a Remain vote throughout the campaign (last seen ranging between Market reaction 70-80% implied probability), further reports from the bookies had raised questions over the predictive ability of these odds given the unconventional betting patterns. With a strong turnout of 72% of the electorate, despite the fairly close result, it does seem clear that a strong mandate has been handed to the government. The initial market reaction has been negative after sentiment in the days preceding the referendum itself seemed to have shifted to favour a Remain vote. With a strong turnout of 72% of the electorate,despite the fairly close result, it does seem clear that a strong mandate has been handed to the government. The pressure valve that is the currency has seen sterling fall particularly sharply, touching levels not seen since 1985, while global equity markets are deeply into negative territory. Whilst market swings witnessed in the run up to the election had more to do with investors trying to second guess one another than true market impact, the prospect of protracted uncertainty across the UK and Europe is likely to keep volatility elevated. Following the immediate shock to UK equities there is scope for differentiation within the market large-cap stocks, which tend to be multi-nationals, could outperform both due to their relative lack of domestic economic exposure and the ability to repatriate overseas earnings at a favourable exchange rate. On the flipside, mid- and small-sized companies are likely to face more pressure, being more tapped in to the UK economy. Despite the current turbulence in markets, we don t believe the economic predictions from either campaign had any real validity and, despite an expectation for a short-term GDP hit, the underlying economic impact is likely to be limited in the grand scheme of things. With little fundamental basis to work on, following the initial impact, markets could stabilise somewhat, though the risk remains that the result is a trigger event that causes renewed investor worry about more substantive factors. As always, it is worth remembering that long-term investment returns are primarily driven by the topdown impact of global macroeconomic conditions, and the bottom-up factors of enterprise and innovation at individual investee companies. Talk to our team - Get in touch for help and advice: 0121 696 4616 enquiry@expatsavingsteam.com 5
Outlook Economists are notoriously incapable of forecasting the path of future growth even when operating in a steady state environment of known rules and a reasonably clear policy. Making bold claims about the long term risks or benefits of Brexit when the terms of any exit are at present unknowable smacks of little more than self-serving rhetoric. We would therefore discount many of the more sensationalist claims emanating from either camp, preferring to focus on what we know or can reasonably expect to happen. The economic impact of the UK leaving the EU is effectively unknowable, but in the grand scheme of things we expect the impact to be relatively limited economies and their agents will adapt, and the shock of the result will dissipate over time. Although uncertainty will remain, with the referendum complete we expect markets to get back to focusing on more substantive issues, which we have been continuing to monitor carefully even while much attention has been temporarily diverted. Perhaps one of the major investment concerns from the Leave vote is the risk it becomes a trigger for pent-up concerns over some of these. At the top of the list is how the US Federal Reserve manages US interest rates. We think the Fed has created a no-win scenario for itself, as its preferred measures of inflation and employment are approaching its targets just as profitability at US corporations seems to be coming under pressure. It now faces the risk of either accelerating the onset of recession by hiking too quickly, or letting an economic malaise take hold without the traditional re-boot mechanism of cutting interest rates. A less probable, at least in the near term, but higher-impact risk is a disorderly unwind of the debt bubble that has been fuelling Chinese growth for the last decade. Sharp but brief falls in global equity markets last summer and again at the start of this year provided a taster of what could happen if China continues to play fast and loose with its capital allocation. Against these concerns, we continue to see pockets of opportunity with policy stimulus continuing to be a key driver of markets in the near term. Talk to our team Get in touch for help and advice: 0121 696 4616 enquiry@expatsavingsteam.com 6
Politics is a growing factor In closing, one key aspect of the EU referendum worth holding on to is the growing impact politics will play in the formulation of macroeconomic policy-making. Globally we are seeing antiestablishment rhetoric growing as extraordinary monetary policy drives an increasing sense of social inequality. Asset price inflation has materially exceeded wage growth for a prolonged period, giving rise to the perception that policy is being set for the benefit of the few at the expense of the many. This in turn is manifesting in antiestablishment politics, evidenced by the successes of Syriza, a far left party, and Golden Dawn, a far right party, in Greece as well as the rise of Donald Trump in the US and Jeremy Corbyn in the UK - regardless of your views of Mr Corbyn, I think most would agree he is decidedly not establishment. Not only is political instability likely to drive volatility in markets, there are also worrying signs of a growing appetite for government interference in the actions of nominally independent Central banks, just as the unconventional monetary policy experiments extend further into the unknown. Uncertainty around how the UK actually leaves the EU and on what terms will remain for the foreseeable future, but is likely to fade into more of a background process. In the meantime, there are more significant factors to consider that are likely to have broader ramifications on globally-diversified portfolios. Uncertainty around how the UK actually leaves the EU and on what terms will remain for the foreseeable future 7