Brexit – The Aftermath

Thursday, June 23, 2016, at the market close everyone felt safe.  The Brexit vote had been completed and everyone was looking forward to the weekend after one more piece of the wall of worry was removed.  As we all know, people generally vote for what is in their own self-interest.  For a citizen of the United Kingdom it was obvious with 40 years of peaceful growth, a rise in the standard of living, and the ability for freedom of movement amongst countries for work and living (it is better to retire in the sun of Spain than experience a cold, rainy summer in the UK).

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Contentment from people that either never experienced or had forgotten the hardships in the United Kingdom in the 1950’s, 60’s, and 70’s resulted in a group of people voting against their self-interest.

What was to be a great summer weekend instead became a volatile financial mess.  The pound fell over 10%, European markets by over 10%, and a general gloom fell over the globe.

Then people realized that it is not binding; Parliament has to approve the vote.  While European leaders showed their anger at Great Britain, cooler heads surfaced.  The Spanish who went to the polls over the weekend went with the status quo.  They have seen the consequences of a severe recession; their unemployment rate, while at a 4-year low, is still over 20%.

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Analysts sat back and asked, “If there is a recession in Great Britain how will it affect China, Japan, India, the United States, and Latin America?”  And the answer is: very little. 

How many fewer cups of coffee will Starbucks sell in the United Kingdom over the next year?  Maybe 5% or less.  And if it is 5% less, what impact would that have on Starbucks total sales?  It is not very much, probably less than five-tenths of one percent.  Growth in China, India, and Brazil could make up for that very quickly.  In fact, emerging markets were down less than half of what the European markets were down.  MSCI Europe two-day return for June 24 and June 27 was –13.41% and MSCI Emerging Market two-day return for June 24 and June 27 was –4.75%.

The event will cause global volatility over the summer, and then over the next few years our estimate is that eventually both the United Kingdom and Europe will do what is best for their own long-term self-interests, which are generally tied to one’s own long-term economic interests.

Brexit for Businesses

With just three days to go until the UK referendum on whether to remain in the European Union, the opinion polls are still returning no decisive idea of which way Thursday’s vote will go and we are asking the question – what would Brexit mean for global businesses?

Wall Street growth investor Louis Navellier believes one of the sectors which will most likely be affected is the energy and commodity sector. With the Energy and Basic Materials sectors currently down by 2%, it is clear that investors are beginning to feel the uncertainty and this is being reflected in the market. Navellier believes that, after a rise in commodity prices at the end of the first quarter, a UK vote to leave would help the US dollar to rally causing energy and commodity-related stocks to suffer.

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Increasing strength in the US is also worrying many UK businesses, including engineering giant Rolls-Royce. Last week the company’s chief executive Warren East spoke out saying that a Brexit would put investments at risk and give Rolls-Royce’s American rivals, such as General Electric and Pratt & Whitney, a competitive advantage.

The main factor in all of these worries is uncertainty. East claiming that the uncertainty about the outcome of the referendum, and the knock-on effect it will have, causing the company to put a lot of important decisions on hold for the moment. This uncertainty, coupled with that surrounding the run-up to the US presidential elections, is taking its toll on investment banking as well. Banking analyst Chirantan Barua recently predicted that a leave vote could cause investment banking fees to plummet by more than 30% globally, bringing deal-making to a halt, and meaning disastrous things for anyone working in Mergers and Acquisitions in London or New York.

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But not everyone is worried, Invesco Perpetual’s Head of UK Equities, Mark Barnett, has said in Investment Week that the UK’s dynamic economy will enable it to adapt to any change resulting from a Brexit. Although the initial effects would be negative, he says, in the long term it is unlikely that there would be any real impact on the stock markets outside of the UK and the best businesses will have planned for both outcomes.

This is an opinion echoed by many global companies who have operations in the EU and the UK. Ingeborg Oie of medical technology company Smith and Nephew, says that, although the company believes the unified EU regime is advantageous – with overarching regulations across national borders allowing new innovations to be shared more quickly and cost-effectively – they do not believe that the referendum will have a significant impact on their ability to do business.

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Amidst the widespread disagreement of what to expect financially from the referendum, there seem to be a few generally-agreed predictions. Whether or not it would be an economic disaster for the UK, Brexit may well give US an advantage over the UK in a time when the dollar is already strong, but this advantage could come at the cost of commodity prices. Secondly, Brexit probably would not impact huge multi-nationals decisively, but would certainly cause some damage if a lot of their work is done in the UK or EU. When it comes down to it, however, it would appear that the only thing that is certain is that the referendum is causing uncertainty.

What is Brexit?

In just over a week, the United Kingdom will make the decision whether or not to remain in the European Union. Should they choose to leave, this could have severe ramifications, not only on their own economy, but on the world’s.

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Currently, Britain is a member of the economic and political partnership known as the EU. Although politics has become inextricably linked with the EU in recent times, the partnership is first and foremost a financial one, founded after the Second World War on the assumption that countries who trade with each other are less likely to go to war with each other. Over time it has grown to become a single market, allowing people and goods to move around as if it were one country, but many in Britain want out.

This is in part due to a growing belief that immigration into the UK is getting out of hands and that a departure from the EU would allow the UK greater control over its borders. Economically-speaking, many in Britain also believe that the country gives a great deal more to the European Union than it gets back. Indeed, after France and Germany, the UK is the country who pays the most into the EU budget, and is one of 10 member states who pay in more than they receive. Exactly how much this is is debated – the most recent Treasury figures say it was £8.8bn for 2014/15, while the National Audit Office sets it closer to £5.7bn.

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Nevertheless, the referendum is coming, and with it growing anxiety as to what this will mean for the global economy. Recent feeling expressed by the Organisation for Economic Cooperation and Development (OECD) is that a vote to leave the EU could be nothing short of devastating. Catherine Mann, chief economist at Paris-based think-tank even said that Brexit would have as great an effect on the global economy as a “hard landing” in China. According to the OECD’s predictions, following a vote to leave the UK’s economy could be around 1.5 points smaller in 2018, the Irish economy 1.25 points smaller and the Eurozone economy as a whole 1 point smaller.

This anxiety is reflected in the markets, the uncertainty -coupled with the political standstill in Spain – contributing to some of the worst yields seen in recent times, with those of the UK and Germany reaching record lows. With the persisting frustration around immigration and high unemployment levels across Europe, many worry that a Brexit could trigger a domino effect in an increasingly euroskeptical Europe. As for what impact that could have on the global markets… that remains to be seen.

Market Commentary – Quarter 1, 2016

After rallying to new highs last spring, the global market went into a sell-off lasting until February 11, 2016; falling on weak economic data in the USA with reported anemic GDP growth of just 0.7% in the fourth quarter of 2015, along with weaker growth reported in Europe and Japan.  On February 11, 2016, fittingly, Don’t Cry over Spilled Milk Day, the market reversed course.  People observed that maybe the reason retail sales were down was that it was a warm winter and people just were not buying sweaters, coats, or spending money on $100 per barrel oil.  Those darn consumers were saving their money.  Just in time, the fourth-quarter GDP was revised up to 1% growth then later to 1.4% — very respectable.  Then along came the “J” curve, and people started spending their savings.

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Economists are talking about a Goldilocks economy: not so hot that it causes high inflation nor too cold so that it causes a relapse into recession. International Monetary Fund Director Christine LaGarde is pushing for a 2% global growth target so that the bear does not come back too soon.  In relation to GDP growth in Europe, we are expecting 1.4%, Japan 0.7%, India 7.4%, China 6.5%, and Brazil is in deep recession at -4%.

The Federal Reserve increased interest rates in December 2015 by 0.25% and will be conservative when/if increasing rates in 2016.  We are expecting the Federal Reserve to only raise rates by 50 BPS in 2016 resulting in a steady U.S. dollar and slow and steady growth in both the U.S. and Global economies.

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Domestically, we expect GDP growth to increase 2.0% in 2016 with a modest recovery in developed markets and slower economic activity in emerging markets.  The only major decline on the global economic front is Brazil, with a projected -4.0% GDP rate of growth in 2016, but it is expected to emerge from its downturn in 2017.  We expect continued 1.4% real growth in Europe, 0.7% growth in Japan, 7.4% GDP growth in India, and a slowing China expansion to 6.5% in 2016.  The aggregate of world economies should lead to global growth in the range of 3.2% to 3.5% GDP growth.  All sources are calling for a close vote on the British exit in the upcoming in-or-out referendum on the United Kingdom’s EU membership and no matter the outcome, will be closely watched by other EU members.  We believe that the equity markets came to a bottom earlier this year and this bottom could serve as a base for further higher moves.