Is there light at the end of the (euro) tunnel?

16 January 2019

The painstakingly negotiated withdrawal agreement was brutally crushed last night in a Parliamentary vote that has few comparisons in the last century of British politics. In the immediate aftermath the opposition leader, Jeremy Corbyn, took up Prime Minister May’s offer to lay down a vote of no confidence in the Government. The vote will take place today. Below we explore what likely happens next and what it means for investors.

What next?

We have warned many times that there is no room for strong convictions in amongst all of this political process. When the main protagonists don’t know what comes next, we should be wary of authoritatively second guessing them. With that disclaimer out the way, most seem to agree that today’s confidence vote will go the way of the government. Last night, there was little apparent appetite to face the electorate (for the third time in 3 years) from the key individuals and groups that the opposition would need to flip to be successful in its motion.

Of course, this is government that is burdened with a wafer thin parliamentary majority, so fresh elections and all the uncertainty that entails cannot be ruled out. Nonetheless, this is less likely than the government surviving to fight another day.

Assuming this is the case, we are then faced with several problems. First, it is still unclear what options Parliament can coalesce around other than a profound dislike of the deal currently on the table and a desire to avoid exiting the EU without a deal.  Second, time has very nearly run out. With regards to the second point, it does now seem likely that some form of extension of Article 50 will be needed. There are even those suggesting that this extension could go beyond the European parliamentary elections in May and its first session in June.

With regards to the first problem, there will be many who continue to argue for a second referendum. The chances of this have surely risen a little in the wake of last night’s defeat, though we would still point out that there remain sizeable obstacles that remain in the path of a ‘People’s Vote’. Assuming the government survives today’s confidence vote, we will hear more in coming days.

What about the economy?

The last few weeks have provided evidence that the economy has continued to list buffeted by the continuing uncertainties surrounding the UK’s manner of departure from the EU. Companies have been building inventories, likely in preparation for hard Brexit, while consumer confidence has swooned. There is very little we can confidently say about the 12-month outlook for the UK economy. The range of potential outcomes remains wide.

Points for investors to remember

A crash out remains unlikely (but not impossible)

As noted above, one of the things that the last few weeks in particular has illustrated is that there remains very little parliamentary appetite for exiting the EU without a deal. The significant uncertainty that would accompany such an exit would, at the very least, be obstructive to an already struggling UK economy.

We suspect that this leaves a crash out, without even a hastily stitched up bilateral deal on essentials such as medicine and food, as unlikely. If the unlikely did happen and the UK was to exit without a deal, we should be prepared for significant short term disruption. Sterling would likely be the medium through which investor angst and downgrades to the UK economic outlook would be expressed.

Whatever the outcome, the world will keep turning

While we can’t say with any great certainty what will happen to the UK economy in the next 12 months, we can more easily say that the rest of the world won’t lose much sleep over it. The UK accounts for less than 5% of the world’s GDP, whilst Continental Europe, for example, accounts for 20%. Continental Europe’s outlook would of course be dented by a severe downturn in the UK’s economy, if that did materialise.

Nonetheless, it continues to be the US economy that sets the drumbeat for the world and its capital markets. Our view of the health of the US is being obscured by the ongoing government shutdown, which will prevent the release of the December retail sales report today for instance. Even so, the data we do have on the private sector suggests demand remains robust in the most important capitalist economy.

The risk of an imminent US recession looks a lot lower to us than an investor base that have recently become overly pre-occupied by the US economic cycle’s chronological, rather than ‘biological’ age. A dispassionate assessment of the recession indicators that have been of some use historically argues for this economic cycle having further to run yet.

Long term investing has little to do with politics or recessions

For those lucky enough to be able to look to the long term with their investments, most of this is irrelevant. The next recession, whether or not the UK leaves the EU, what comes next from President Trump are little more than noise. For such investors there are really only two questions.

First, is humankind more likely than not to continue inventing new stuff and get better at using that new stuff? Remember, it is these forces of innovation and productivity that we are accessing when we buy stakes in, or even lend to, the companies and governments that dominate the world’s capital markets. From our perspective, humankind’s impressive track record over the last few centuries suggests that we deserve the benefit of the doubt here.

Second, is the price of the ticket that gives us access to all of these innovative forces fair?  For this, we can certainly argue that certain parts of the world’s capital markets still provide tactical opportunities to be taken advantage of. This is why our tactical portfolio still leans gently towards developed and emerging stocks at the expense of government bonds for example. However, these discrepancies are unlikely to provide a major headwind, or even tailwind, to long term capital markets returns. Now looks as good a time as any to enter that long term bet.

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