It was undeniably most unnerving week in UK politics since the week that followed the surprise of the British electorate choosing Brexit over the status quo of remaining in the EU. Now that the representatives of both sides have finally agreed on a route called the withdrawal agreement that lays out how to achieve a Brexit that is not so disruptive that it throws both sides into economic turmoil both sides of the UK’s Brexit spectrum are screaming in disgust.
This either means that it is truly a compromise that has been negotiated which in its nature makes neither side particularly happy. Or, it is dawning on the Brexiteers that the whole ‘cake and eating it’ idea really has no chance of becoming reality and instead of owning up to the blunder they have returned to their cloud-cuckoo-land in which this is simply the wrong Brexit plan. The Remainers on the other hand see the turmoil of the “Brexit means Brexit” government as their chance to reverse the referendum outcome and return to the safety of the old status quo.
It was therefore interesting to note that in all of this noise only the business community appeared to support Theresa May’s moderate route of a gradual EU divorce that would neither return the UK entirely to its pre-EU membership nation status right from the start, nor immediately expose it to having to re-establish new trade terms with not just our neighbours and largest trading partners but the whole world. Or was it perhaps that once again only the noisy fringes made themselves heard whereas the majority in the middle kept stumm, because they realise that what is on offer may not be so bad but is nevertheless only the best amongst suboptimal choices and therefore a hard sell.
While there was much citing of adverse market reaction as if to prove the severity of the situation not just in terms of government continuity, our volatility chart below for the UK’s currency and stock market shows that capital markets were far more alarmed during the summer of 2016 and even the Q1 2018 stock market correction. Pessimists will argue that stock markets have simply not correctly priced in the rising probability of a disorderly no-deal Brexit crash out. We would instead side with the markets and suggest that the balance of probabilities stands against such an outcome and a higher likelihood that MPs will in the end support the lower risk option of ‘Brexit means Brexit’ on Theresa May’s terms rather than opt for the higher risk course of shying away from the historic responsibility of signing off a suboptimal choice for the nation and instead asking the electorate for a second opinion – which may cost them their seat. The no-deal option remains too unpalatable for anybody seeking re-election.
We have suggested since the summer that the end process would get very unnerving, unpleasant and outright frightening, but in the end, we would get some form of a Brexit fudge rather than a disaster. The possibility of a second referendum may have risen over the week, but we still regard this as a low probability outcome, unless the EU suddenly offered some concessions around a pan-European migration framework which we attach a low probability to.
For the UK asset we hold in our investment portfolios, we believe that there comparatively low valuations reflect the most likely outcome of a lengthy muddling through towards a sort-of-Brexit, while the downside risks inherent with this position is well balanced by the possibility of a better than expected outcome.
We suspect our readers and clients are just as fed up with having to read about the Brexit process as anybody else across Britain and so I am more than happy to leave all further political comment to the journalist experts and their weekend papers.
While the Brexit drama for once caught international attention, it was still not the centre of attention for capital markets. Instead there was a certain air of 2015 déjà vu as the oil price accelerated its fall to reach -25% since its early October peak and the price of credit for the highest risk borrowers rose, while the demand for save heaven government bonds drove their yields down – for the first time during this correction. As during any previous risk-off period, voices are growing louder that are suggesting that the stock market is just anticipating what is not yet really visible from the data flow – a looming downturn. Cleary, the longer the current economic cycle lasts the higher the probability that such predictions eventually prove correct, particularly now that there is a real threat to the global trade framework through Trump’s trade war threats towards China and a lesser degree Brexit.
It is also undeniable that beyond the US economic growth has slowed compared to 2017, with emerging market economies bearing the brunt of China’s demand slowdown and Trump’s fiscally driven US$ strength. However, if the biggest risk to the global economic cycle is the risk of a disorderly unwind of the bond market from historically low yield levels, then lower oil prices, lower US government yields and a reduced rate of global growth are all factors which lower the probability of such a bond market ‘riot’ actually occurring in the near future.
So, while the various signs of slowing are eerily reminiscent of late 2015, neither the oil price decline, nor the economic activity reduction are anywhere near the levels of back then – the global economy is in a more stable environment. But, just as the lower oil price and lower yields of 2015/2016 turned into a formidable stimulus for late 2016 and 2017, so have the current price changes the potential to serve as stimulus for 2019. Unfortunately, the pain of price adjustments to the changed outlook comes first and the benefit follows only with a time lag. Therefore, unless politicians either in the US and China or the UK and the EU provide us with somewhat unexpected positive surprises towards a resolution of the trade tensions, then the prospect for positive investment portfolio returns for 2018 are dwindling.
Sorry for being the bearer of negative news, but it does appear that what started as a very strong economic environment may once again be turning into a mini downturn, which introduces unwelcome market volatility but ultimately extends this economic cycle for yet another year or more.
For our clients though, any short term market volatility becomes less of an issue. The cashflow modelling we do for our clients where their future is “stress tested” against the impact of any market issues we can offset any concerns against longer term goals.
To find out more or if you have any questions, please feel free to contact us