Comment and opinion for retail investors in the UK
I always want to write this piece without
mentioning Brexit but given the changes of the last couple of weeks, I have to
bring to your attention a flavour of the opinions of strategists and commentators
in the investment market and my own take.
When Mrs May was Prime Minister, political sketch writers tended to suggest her Brexit department ministers had no plans and that she just robotically repeating ‘red lines’. In the end civil servants in the UK and the EU came up with a technically sound withdrawal agreement, but as we know a chunk of the Tory party really don’t like it. So as a consequence we have a new Prime Minister.
The unsurprising election of the new Tory leader and therefore (at least for a while) Prime Minister is bound to be of interest to investors, because it changes the dynamics of the everlasting Brexit saga.
In the short term, any stock market reaction will be ‘false’ because there is no new certainty. In a few weeks, the range of possibilities will narrow down.
The EU wants post Brexit Britain to deal with it in as similar s way as possible as now, because that is in its best interests. Arguably, if free movement was stopped, so would most British people – the sovereignty and common market stuff is less motivating for many, although I do realise not all.
I think the EU will not fall over at any new bravado from the new PM, but may well want to offer him enough concessions to get a deal through Parliament. After all, they are politicians too.
Investors need to pay more attention to what the situation looks like in late September. A no deal exit is without any doubt going to impact UK investment markets like a thunderstorm, if not a tornado. A smooth exit with a managed deal (sort of softish) would see a relief rally.
What do I think will happen? I really have no idea, so am keeping plenty of cash on hand to maximise my options.
I read today on the Bloomberg new service that the yield on US Treasuries (which is a quick way of summarising the price of US Government bonds) has fallen to a level that implies the US Federal reserve will CUT interest rates 3 times next year. That is not altogether what one might predict!
It seems that worries about trade wars and other factors are prompting big players to buy Treasuries, either to profit from such rate cuts, or because they think there will be a US recession, or both. Apparently there is a strong view that such a recession is on the way. If there is and bank rates fall then the ‘hedge’ might work and provide some compensation when equity prices collapse.
But the idea of a US recession is hardly good news. Much as we don’t rejoice in making an insurance claim when some disaster happens, we are unlikely to be happy to make a bit on our exposure to the US bond market if we are seeing our equity portfolios trashed.
What if US interest rates don’t fall? With very high employment levels and Trump’s tariffs likely to push up inflation, then there is some probability that they won’t. They may even go up more. In that case, the yield on Treasuries will need to rise and values will fall. That may also be bad news for equity markets and furthermore at some stage a recession will happen. So there could be a double whammy.
In that case investors will have to ponder the storm damage and realise that the insurance is not going to help.
I take the view that as political risk remains (unusually) the most significant and that means normal economic considerations are out the window, it is best not to bet on the direction of interest rates but to assume a revaluation downwards in equity markets as troubles build up. In that case, I prefer to hold cash.
The stock market reaction to last night’s drama in the House of Commons is muted so far, both locally and globally (I write this at around midday on January 16th). Sterling has strengthened which has been explained by no less than Mark Carney as evidence that the markets believe that a Hard Brexit is less likely and a delayed Brexit is on the cards, allowing a more sensible deal to be done.
I was a Remainer and given that I have chosen to live in Europe as an EU citizen, I can only confess to blatant self interest. I also voted for the first time ever in 1975 to join the EEC and still believe in the post war idea of a stable Europe being more likely with formal economic and social unity. I know that is not an argument everyone likes but I see much good week in week out in the projects for young people that are made possible by the EU.
As a financial and investment expert (sorry Mr Gove), I did and still do genuinely believe that Brexit was always going to cause economic damage to the UK in the short term. If anyone ever wants to know why, I can explain in great detail! Over the longer term, I can see both sides of the argument. I would have preferred the threat of a Brexit referendum to have been used in collaboration with the other EU countries who don’t like the Brussels set up, to seek reforms. Also I would have preferred some honesty all round.
I do agree with something said by many – that the decision of the referendum ought to be carried through, unless there is a second referendum as a result of a genuine public desire for one. It is not for Parliament to simply stop the process because the Government has proved to be an utterly incompetent negotiator. I suggest it is better for Brexit to happen, the consequences be dealt with (and I think they will mostly not be happy) and perhaps a new relationship with the EU established after a period of reflection.
I understand very well the arguments for and against EU immigration because my parents and sister live in Lincolnshire and I personally know people of all ages who have come to the UK from Eastern Europe (many have returned now but some hold very well paid jobs in major businesses and public bodies) and also seen first hand that working in the UK has been an economic choice for young people with English language skills. It is definitely not the first choice any more for the brighter kids and places like Germany, Norway and even the USA will be getting skilled young workers who would have come to the UK.
What can investors expect? The first point I need to repeat is that Mrs May’s deal and whatever replaces it, unless that is a Hard Brexit, represent the beginning of the exit process, not the process itself. There will be many hurdles to overcome, some bonuses and some unexpected complications. Change involves risk and cost – always! So I remain pessimistic about levels of volatility, especially as currency exchange rates are much more a part of the risk assessment that they used to be. I am not rushing to invest anywhere in the world.
On the plus side, Britain has a developed economy with strong control mechanisms and an enterprise culture so a sell off on grounds of uncertainty only will throw up bargains as excellent businesses will have their share prices marked down below the levels justified by their profit and dividend paying potential. That implies a case for investing in the UK in stock picking ‘special situations’ and smaller companies funds.
Personally, I have already dipped my toe in the water by buying a small weighting in a leading UK small companies fund and been rewarded by a sharp loss to date! That is often what happens when one tries to see through the fog and into the future. More often than not, an initial set back precedes several years of excellent returns!