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Skerritts View - July 2016
It’s all About Brexit: At Least for Now
They think it’s all over, well it is now. The referendum that is, and after four months of vigorous campaigning on both sides, it’s probably fair to say that the result came as a surprise to most people, and certainly to markets. A remain vote had been expected by currency traders, right up until just after 10pm on Thursday night with Sterling rising to 1.50 against the Dollar. (Bloomberg.24.6.16) However, things quickly unwound as results started to come in, with the Pound dropping below 1.33 in the small hours after midnight. As expected equity markets followed suit with sizeable falls across UK & European stock markets on Friday and then again on Monday.
The result however is unlikely to lead to a disorderly Lehman-type market sell-off in our opinion. The global banking system is much stronger than in 2008 having undergone numerous stress tests. According to the Financial Times (25-06-16) “The financial system continued to function in an orderly manner as a statement from the US Financial Stability Oversight Commission pointed out late on Friday night. Translated from geek speak, that means markets did what they should — reprice the risk of assets to reflect a changing world”
We may therefore be facing a period of market uncertainty and volatility more akin to the European Crisis of 2011 than the dark days of 2008. Hopefully though, with a co-ordinated response from The Bank of England and The European Central Bank, the effects of this latest crisis will be more muted.
UK politics on the other hand has been thrown into huge turmoil with David Cameron announcing that he will stand down, and importantly, that it will be for a new leader to decide when to file Article 50 of the Lisbon Treaty, which will formally start the two year exit process. The challenge for the new prime minster is to unite a divided country which spit 52/48 in terms of the overall leave/remain vote, but also significantly along age lines. Lord Ashcroft Polls (lordashcroftpolls.com 24.6.16) stated that “The older the voters, the more likely they were to have voted to leave the EU. Nearly three quarters (73%) of 18 to 24 year-olds voted to remain, falling to under two thirds (62%) among 35-44s. A majority of those aged over 45 voted to leave, rising to 60% of those aged 65 or over.”
As regards invoking Article 50 of the Lisbon Treaty, no country has done this before so it is not clear what exactly will happen. The EU seems to want the UK to do this sooner rather than later but the Government has an incentive to wait before initiating the two-year countdown process until it has formed a negotiation plan, since the EU is likely to take a hard line on the U.K.’s access to the single market. The two-year negotiation timeframe is not set in stone as the U.K. could withdraw beforehand, or, with approval from all member states, it could negotiate for more than two years.
Overly Pessimistic or Blind Optimism: How will the UK fare?
This seemed to sum up much of the rhetoric from the two camps during the campaign, with lots of oh yes it will, oh no it won’t moments, such as George Osborne warning of an instant DIY recession (27.6.16.Independent.co.uk) or Michael Gove saying BREXIT won’t cause recession (27.6.16.Telegraph.co.uk). Even amongst sources we trust there is a divergence of opinion. Natixis Asset Management state that the implications of Brexit are unambiguously negative for the UK economy.
They see the inevitable further depreciation of sterling being particularly harmful given the country’s large current account deficit financing needs. They also state that the ensuing contraction of purchasing power and imports, delays in foreign investments, and loss of business and consumer confidence, should undoubtedly translate into an economic recession as early as next year. (27.6.16.ngam.natixis.com) economic recession as early as next year. (27.6.16.ngam.natixis.com)
BCA Research (24.6.16) on the other hand see things in a different way “ If anything, the damage to the U.K. economy is likely to be fairly modest considering that foreign tourists have now received a “10% off anything you buy” coupon from the British electorate. The resulting boost to net exports should offset much of the drag from diminished business confidence.”
Whatever the longer term economic consequences political uncertainty seems to be rising on a daily basis, with the Labour Party maybe looking for a new leader, along with the Conservatives who definitely are. Factor in the possibility of a second independence referendum in Scotland, together with renewed tensions in Northern Ireland, and the only certainty in the near term is uncertainty.
There are similarly large challenges for Europe in what could be viewed as the biggest shock to the status quo since the fall of the Berlin Wall. Stark choices lie ahead. With Britain out of the way do politicians of Germany, France, Italy and the Benelux countries seek to push ahead with policies to integrate Europe more quickly into a federal structure, which is arguably a natural extension of the adoption of the single currency? Alternatively do they pay more attention to decentralisation and only seek to integrate further where necessary while allowing more decision-making at the national level.
Either way what has happened in the UK could trigger other populist demands for similar referendums. With no fewer than five general elections coming up in the next 18 months there may be campaign promises from various parties offering referendums on EU membership. Do the voters latch on to a once in a lifetime opportunity and vote these parties in order to have their say? Or do the voters do as they did in Spain at the weekend and rally back to the incumbent out of fear of change? In any case we may see a raft of new buzzwords being introduced such as DEXIT (Denmark), SWEXIT (Sweden) or even FREXIT (France)?
A referendum in France would be of huge significance, but still seems highly unlikely even allowing for the rise in Euroscepticism within the country. Of more concern is Italy. According to BCA Research, Italy has not seen any improvement in competitiveness and remains embroiled in sub-par growth. The constitutional referendum in October – on streamlining governance, a necessary step before embarking on painful structural reforms – could fail, leading to an early election late this year or early next. At the moment, the anti-establishment Five Star Movement (5SM) is closing in on the ruling Democratic Party in the polls and its leader, Beppe Grillo, has called for an EU referendum.
A “Who is Next” premium will undoubtedly be applied to European assets now that the U.K. has voted to leave the EU. However, it will likely overstate the risks of other countries following suit and therefore could offer buying opportunities if prices fall too far.
Please note that these are our opinions and for information only. The content should not be taken as a recommendation of any investment and does not constitute advice.