Brexit – The End Game?

Brexit – The End Game and the Effect upon Investment Markets
Could we, finally, be witnessing the denouement of Brexit?  Whilst it seems unlikely, given that Parliament is split in half and the government is in the minority, if there were to be a general election with a successful outcome for Mr  Johnson then there is a chance of a last minute deal being struck with Brussels, thus saving face for all.  Happy days.  

The problem is that the alternatives look rather less attractive: a hard Brexit, a ‘dead in the ditch’ Mr Johnson, a Marxist government, a decision about our future taken by the courts, a bad deal with EU, a continuation of the uncertainty and frustration of the past three years or others that might emerge over the next few days.  All lead to uncertainty – investment markets dislike uncertainty, despite having grown accustomed to it!  The few lines following consider the effect (if any) on investment markets and how it might be manifest. 

Growth, Post-Brexit: does it matter?
An ex-head of the WTO described Brexit as ‘removing an egg from an omelette’.  Laws to remove the UK from the jurisdiction of the EU can be passed but capital flows are inexorably linked.  Brexit shall damage but not sever these ties – whether they are stronger or weaker in the future is irrelevant since we shall all just learn to live with them.  Would it matter if in 10 years time the UK was shown to have had a growth rate lower or higher than that, say, of the US or Germany since Brexit?  The analogy is sending a child to school.  You do your best and accept the outcome.  Whether or not little Janet or Johnny would have faired better at the school down the road could never be known; to look back in the future at the effect of Brexit on the UK  is a matter of interest for economic historians, only.  The point is that whatever happens Britain shall still exist as part of a global economy.  It is the global economy that should matter more to the investor.  Thus, when considering the impact of Brexit on investments one must first consider the global position and think of investments from a global perspective.

Global Investment Markets – Bigger Fish to Fry
Global investment markets recognise Brexit as a threat, but not to the same pessimistic extent as some in the UK and equally, with less excitement than those in the UK that support a no-deal.  Global investment markets are more concerned with the progress of the US-Sino trade war (good news on this front yesterday), of the lack of inflation worldwide (a major long-term factor caused by the ageing populations in the developed world) and the need for further stimulus.  This last point is significant – stimulus through quantitative easing (QE) has had the effect of reducing interest rates since the global financial crisis (GFC) of 2008.  Interest rates are now so low that some government bonds pay negative rates of interest – the investor pays the issuer the coupon!  (There are many excellent articles online as to why an investor would wish to buy an investment and then periodically be required to pay the issuer for the privilege of holding the investment.)  Apart for the apparent illogicality of this it begs the question as to how governments can supply further stimulus to encourage growth which is stubbornly absent from the economy of the developed world.

Impact upon Investment Markets – Sterling Bears the Brunt
Given the need to stimulate economic growth it seems that interest rates are highly unlikely, whatever the Brexit outcome, to increase in the near or medium term.  Low interest rates have a positive effect on equities, especially those that pay dividends on profits derived from their global activities.  Approximately one-half of the constituents of the FTSE100 index comprises of such companies.  The concerns about Brexit have, undoubtedly, suppressed the valuations of such companies over the past few years.  Compared to other parts of the globe UK equities are inexpensive but they may become cheaper still following a hard Brexit or the election of a government less in tune with the ideals of capitalism.  

The vehicle that has taken the brunt of the pre-Brexit fear is sterling.  Somewhat ironic, though, since the objective of central banks, post GFC, has been to weaken their domestic currency, rather than to strengthen.  It has been a race to the bottom, which sterling has won.  This is of great significance to those investors that allocate their investments globally, rather than focus on domestic lines, since the value of overseas assets has benefitted from sterling’s decline.  Of course, one day sterling shall recover and, perhaps, at that point portfolios should be weighted more towards the UK.  

Impact upon Investment Portfolios – Little as Yet
My last note was issued in December 2018.  (I apologise for the paucity of notes since then.)  At that time, investment markets had experienced three months of sharp declines – it was a period of heightened volatility caused by a mistaken increase in interest rates by the Federal Reserve of the US.  Over the course of the following three months (to March 2019) the paper losses had been all but recouped and, apart from a blip in August of this year, investment returns have been much better than expected.  Indeed, the total return posted by FTSE100 to date is 12% – by comparison, this firms’s Enhanced Growth portfolio is 17%, Growth portfolio 14%, Growth and Income 13%, Income 10%.  The actual returns earned by your investments will differ due to charges and stock positioning.

The point is though that the proverbial individual walking along Haslemere Boulevard might be surprised that the investment markets have provided growth a such levels over the course of this year, especially if the individual was listening to all the doom and gloom surrounding Brexit.  There are bound to be shocks coming our way but I believe that with a diversified portfolio, both globally and by asset class, one should be able to weather the storm.  Ultimately, the continuation of low inflation and low interest rates should act as a strong foundation.

Quite deliberately, I have made few alterations to the portfolios in light of Brexit.  Given that I am not possessed with the ability to read the future I do not know the outcome of Brexit (if there ever is one!).  I do, though, believe that a diversified portfolio managed with a considered approach is better than a knee jerk following every market announcement.  

Over the coming weeks I shall be visiting you all to report on and discuss your portfolios.  Let us hope that there is, indeed, a resolution to the Brexit debacle by then. 

With kind regards,

Andrew Longbon

For, and on behalf of, Longbon & Company