From flash crash to cash – as a hard Brexit now looks more likely, Brian Tora takes a look at what is happening to the UK economy with all the uncertainty from the UK’s vote to leave the EU. And confesses that his crystal ball is somewhat opaque.
Nobody can accuse the investment game of being dull at present. Since the surprise decision of the British people to opt for leaving the European Union, the FTSE 100 Share Index has flirted with its all time high, while sterling has sunk to a 31 year low against the dollar and at one stage was at an all time low against the euro. Arguably that is good for exporters, but it is a bit of a trial if, like me, you are paying local builders in euros to complete the renovation of a property on the continent.
What would a “hard”Brexit mean?
EasyJet said it all when it published some disappointing results recently. Brexit is making their life tougher and the slide in the pound is simply adding to their woes. There will be other companies similarly affected and we have yet to see if the higher cost of holidays abroad will lead to fewer taking the trip to the sun. Of even more importance is whether a hard Brexit will lead to lost business opportunities and more difficult trade terms. The next couple of years promise to be interesting, to say the least.
Markets hate uncertainty
The rise in shares and the fall in the pound are both easy to explain, even if such a reaction can appear perverse. Sterling fell because of the uncertainty created by an unexpected decision to leave the EU. Markets, particularly foreign exchange, hate uncertainty, so traders dump the currency at risk. These days such decisions are, as like as not, the result of an algorithm which tracks news on likely influences. For example, a “flash crash” in sterling earlier in October was blamed on computers picking up on Francoise Hollande stating that Britain should not receive any favours on exit, though a fat finger trade in Singapore looks as likely.
The pound certainly developed the jitters in the wake of the Conservative party conference, when our new Prime Minister took a firm line on our leaving negotiations and set a date for them to commence. Suddenly markets took on board that Brexit was real. And May’s comments were, unsurprisingly, interpreted as inviting a tough line back from our soon to be ex partners in the single market. Sterling, which had already suffered in the wake of the referendum decision, dropped further. The realities of what life outside the EU might mean were beginning to sink in.
But a weaker pound helps the Footsie. The top 100 companies listed on the London Stock Exchange are multinational giants, many earning the bulk of their profits overseas. Not only are they relatively unaffected by any perception of a slowdown in the British economy (though there is no evidence for this – yet), but the profits they earn in dollars or euros are suddenly worth that much more when converted back into sterling. It’s an ill wind…
Back to the future
It is to the future we need to look, though. Frankly, my crystal ball is decidedly opaque right now, but it seems inconceivable that the cloud persisting over our currency is likely to disperse any time soon. This may mean little for those invested abroad or holding market leader funds here, but smaller companies may find the adverse winds of opinion blowing against them. Of course, this may well turn out to be an unfair judgment – on both counts – but markets are often more emotional than rational.
The trouble is that it will take time to know with any degree of certainty how the future will pan out for UK plc and the good companies that sail in her, but most investors will not sit back and take the longer view because of the perceived risks.
UK financial services business under threat
Let’s look at financial services. Once upon a time banks were the largest constituent of the FTSE 100 Share Index, but the collapse of Northern Rock and Lehman Brothers put paid to that. They are, though massive contributors to the wealth of our nation, along with the investment management companies, insurance firms and other ancillary businesses, many members of which will be reading this article, that go to support our position as the leading financial centre in Europe.
Already we learn that plans are being developed to take at least part of the UK based operations of these companies into a European financial centre where they can retain the passporting advantages that may be lost by our departure from the EU. Paris and Frankfurt are well aware of the opportunities that might open up, so you can expect some heavy lobbying in these areas. In other words, Brexit could see some tough – and unpleasant, for us – conditions being imposed upon us. Goldman Sachs has warned of 2000 job losses in London if conditions are tough.
A tough EU stance is likely
Part of the problem lies in an uncertain political environment in Europe – not that the situation at home is that straight forward. Germany and France are both due to hold elections next year. The immigration issue is clouding both campaigns – but then arguably that is what swung our own result to the leave side. Changes in the outcome in either country – less likely in Germany than France – could shift attitudes. Other EU countries have their own concerns – witness the Hungarian referendum – but Brexit negotiators on the EU side will be anxious to deliver a message stating that leaving ain’t easy.
It is worth remembering, though, that a strong part of the argument put forward by Brexiteers was the unsustainability of the current model for the European Union. A single currency has always been viewed as a potential Achilles Heel. Professor Tim Congden once remarked to me that it couldn’t happen. When, later, I pointed out he had underestimated the political will to introduce it, he unrepentantly said it wouldn’t work. And it still may not, without greater fiscal and monetary union within the single currency zone, which suggests creeping federalisation. Not every nation will accept such a move. I doubt we would have.
The Westminster debacle
At home, the absence of a serious opposition to the Conservative government is more a problem than a facilitator in the difficult decisions that will need to be taken. UKIP to the right, Labour to the left – neither look able to challenge decisions taken. Indeed, it has been suggested that the only real opponent of the government at present is the market. Some decisions should be easy to take. We already know from Chancellor Philip Hammond that infrastructure spending is likely to be upped, but we are short on detail and some of the anticipation is already priced in.
So the portfolio planner is faced with a difficult task over coming months and arguably even years. Perhaps the UK will be stronger outside Europe, but it will be some time before we know. And maybe Europe will break apart, but that is far from certain. A few calls seem safe. Gilts have already taken a tumble because inflation, imposed through the higher cost of imported goods, is likely to rise. Equities, given their international exposure, might sustain recent upward momentum, but uncertainty will rule for some time, which means greater volatility. Clients with a nervous disposition could opt for cash.