Economics

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!

September 15th 2018 will mark the 10 year anniversary of the event that history will record as triggering the financial crisis that was followed by global reactions that would have been seen as impossible in earlier times.  Most developed economies moved their central bank rates to be net negative (in real terms) and central banks became the largest buyers of fixed income securities that have ever been seen, adding trillions to their balance sheets and effectively the same amount of new liquidity to the money markets.  Money printing is not really the best shorthand, but that is what the average person easily understands as being the process.

It is perhaps disappointing to politicians and especially the top central bankers that they are not thanked much for acting to prevent a recession like that of the 1930s.    However, the consequences of these actions have not yet fully worked their way through.  Some have been good for many people – asset prices have risen as would be expected when there is loads more cash sloshing around.  But because austerity was an accompanying part of the economic package in many major economies, there have been negative consequences for those who have no assets, or whose main asset is their human capital – their ability to sell their labour.  Wages have not risen much because of contemporary changes in technology, society and the relative power of the socialist vs capitalist elements in politics.

It is in fact a rather unfortunate irony of the post financial crisis world that the solutions adopted to sort out the mess directly caused by irresponsible financial engineering – the invention of extra fictitious assets for those who already had plenty of assets – is in fact an application of more short term financial engineering.   This is like giving the drunk guy another bottle of vodka because you feel sorry for him.

It is also much the same as the high interest rate lender offering a consolidation loan to the person who has got in a mess and can’t pay their credit card and bank loan instalments, knowing that they will struggle with the monthly cost but that there are valuable assets to be had if they default.  The world remains relatively Dickensian.

The respected fund manger Edward Bonham-Carter (c0-founder and formerly managing director at Jupiter) recently made the point (in a piece about this 10 year anniversary) that global indebtedness is now at astronomic levels.  In some emerging markets the stress of such debt is being thrown into sharper focus by the rising value of the dollar and less than stable politics (Argentina and Turkey).  But debt in much larger economies is gigantic in comparison.

Most of the warning signs that preceded the last stock market collapse are now flashing, some quite urgently.   As always the market won’t correct itself by slowing down gently and having a long pause, even if a proportion of participants know when to start taking defensive measures.  It occurred to me once that maturity is knowing which drink is the last one you can have before you lose control and get ridiculously drunk with all the negative consequences.  Most global stock markets have had that last ‘sensible’ drink.  Some more drinking will no doubt raise a further temporary feeling of joy without consequences, but the hangover will be nasty.