The political situation
In the space of two weeks, the UK has voted to leave a union of which it has been a part for forty years. It has lost a prime minister, has seen the departure of a number of key figures from the Brexit camp, and now faces the prospect of a new Conservative prime minister and the very real possibility of a general election by the end of the year. Even this doesn’t cover the full situation, with the Labour party paralysed by civil war and the Scottish National Party now openly talking about a second independence referendum.
Amidst all this, the one island of calm has been the governor of the Bank of England. Mark Carney has essentially become the soothing voice for the UK, speaking on TV soon after the vote result was announced and then making regular appearances to outline the actions the bank was taking to cushion the impact of the vote on the UK economy.
In terms of the UK/EU dynamic, things have been remarkably quiet. Jean-Claude Juncker, Donald Tusk, Angela Merkel, Francois Hollande and a string of other leaders have made pronouncements on the situation, but essentially the relationship between Britain and its ostensibly erstwhile EU partners is unchanged. Until the UK hits the button to activate Article 50 of the Lisbon Treaty, and begins the process of withdrawal from the EU, things actually stay as normal. This, of course, does not take into account the uncertainty created by the Brexit vote. Negotiations have not started, nor have negotiations about negotiations, so for the time being we must simply sit and wait.
The economic outlook
The UK’s vote to leave has created a watershed moment for the UK economy. At present, it is too early to tell what the exact effect will be, with the Office for National Statistics suggesting that the impact will only start to become clear in August, when the full set of data for July becomes available. Even then we can expect to see only an incomplete picture.
The Bank of England now looks set to unleash fresh quantitative easing later in the year. Mark Carney’s main tone has aimed at indicating the range of options available to the Bank of England in case of further market and economic turmoil. It is possible that the Monetary Policy Committee (MPC) will look to announce fresh easing at its meeting in July, although this may be too early on given the above point that July data will only just be starting to filter through. At present, QE’s function is not necessarily to provide further liquidity but simply to send a message that policy can be loosened. Open-ended QE is likely too far-fetched, but at this point anything can happen.
We can expect to see a hit to GDP in the UK, but also for the EU as a whole. The potential loss of one of the EU’s most important members is certain to reduce economic growth, as businesses rein in investment and hiring, and move operations out of the UK. We may see further accommodative policy from the ECB as well, as the bank looks to act in tandem with the BoE to provide a cushion.
We have seen some of the most remarkable volatility across asset classes since 24 June, with wild swings in stock markets and FX crosses, while gold has surged and government bond yields have fallen. It is difficult to draw long-term conclusions from the gyrations of the past two weeks but it is likely that the weakness in sterling that has carried IN_GBPUSD to its lowest level in 31 years is set to continue, perhaps pushing the pair yet further towards the real lows of the 1980s, or even towards parity.
Safe havens are back in demand once again, and look to stay popular for the foreseeable future. Gold’s move above $1300 signifies that many investors are keen to add the metal to their portfolios, and while this is in one sense a diversion of funds into non-productive assets (gold pays no yield after all), it has meant that gold and silver stocks have been very good performers. In other safe havens, government bonds continue to see inflows, pushing more into negative yield territory. This is an insane state of affairs, and is perhaps an indication of just how terrified investors are. When there are so many companies going cheap and offering decent dividend yields, to stash money away in bonds would seem foolish.
Equities have been decidedly mixed, but what is emerging in UK assets is a clear preference for the FTSE 100, and in that index the companies doing best in share price terms are those with significant businesses overseas. This flatters their earnings when translated back into sterling, while the diversification away from the UK makes them more attractive. Strong yields at a number of firms also add to their attractiveness.
One area that has provoked concern is that of property trusts, with a number gating investors and preventing withdrawals. This should be a temporary development, and indeed over the longer-term London property trusts should still provide good returns, as investors realise that demand for office space is not going away. Residential property is a slightly different concern, but if the BoE cuts rates then house price growth should not slow disastrously.
With so much still to be decided, investors will find it hard to look past the near-term. However, it is possible to see a positive outcome over the longer-term, provided any separation of the UK from the EU does not turn acrimonious. Only time will tell, but the Brexit vote of 2016 could mark a new phase in the post-2009 bull market.