This article was originally commissioned and published in December 2015 for Investment Life & Pensions Moneyfacts. Tom Murray considers the troublesome wait for Brexit and how this uncertainty could cause major volatility in the investment markets.
The Brexit circus is coming to town
The UK investment sector is about to undergo a crisis, one made no less severe because it is self-inflicted and bears no relation to the UK’s economic fundamentals. The possibility of the UK leaving the EU - Brexit as it is colloquially, and rather unpleasantly, known - is about to bring a whole lot of chaos to a financial market near you.
There has been a lot of commentary about what type of investments will be available, and/or suitable, if the UK leaves the EU but, in my opinion, we are a long way from having sufficient information on that point to make a credible judgement. The immediate problem is that the whole referendum process is a long, drawn-out one and this process itself is likely to have a dramatic effect on investment strategies in the short and medium term.
The key issue for making strategic assessments of investment quality is the stability of the environment. Forecasting future growth is based on having an ability to predict with reasonable accuracy the likely economic trends in a country. The trouble is that the referendum process and its possible aftermath will take us into unchartered territory – an area ideal for speculators but not for long-term wealth creators.
In particular, advisers of retail customers will find it difficult to find safe havens with a high chance of good stable growth in an era of dramatic uncertainty and instability. Providers with guaranteed return products may well slash the guarantee levels as the volatility of the markets forces them to reduce the level of risk they are taking. Shadows of the Equitable Life disaster hang heavy over the market yet.
The big problem with the process is that we have no idea how long it will run for. The Brexit circus could come in anything from one to three acts and no one can be completely sure how long each one may last for.
Act One covers the run up to the referendum. The referendum can be held anytime up to the end of December 2017, although the likelihood is that it will be held during 2016. Hence the first stage, the pre-referendum stage will hopefully only last for about a year from now.
This stage will involve the results of the government’s current re-negotiation being debated loudly throughout the media along with the fundamentals of whether Britain should be in the EU at all. The resultant discordance within the UK on the subject will be fully on show, as will the split within the political and journalistic circles on the benefits, or otherwise, of membership.
Opinion polls will be taken regularly throughout the campaign. As is their wont, these will likely throw up the occasional surprise on one side or the other; if you take enough polls, a certain amount of rogue ones will always emerge. This will likely have the effect of causing mild panics in the market on a regular basis, right up to the day of the vote.
People planning to retire in the next year or so, therefore, would want to be very careful of how their money is invested, as the market is likely to be unpredictable, rife with rumour with values moving wildly across the period. This is exactly what you don’t want when you’re approaching the time to make decisions about your pension.
Things should settle down quickly once we get to referendum day, providing the dominating vote is to remain in. The markets will stabilise and resume their normal course. Financial planning and investing can get back to working under their regular normal conditions and all will be well.
However, the political and constitutional can of worms that would be opened up by a vote in favour of leaving the EU would not be easily contained. In the event of a vote to leave, we would enter Act Two of the drama – the re-negotiation of the UKs relationship with the EU.
Given the shock a vote for departure would undoubtedly cause in Brussels and among our EU partners, we cannot expect them to be in a very ‘giving’ mood to a country that has rejected them. This is particularly true for the UK; it is one of the big three economies within the union, and its departure would considerably downgrade the EU’s position on the world stage, and reduce its global political clout.
Expecting the twenty-six remaining countries to be accommodating to the UK’s wishes is therefore expecting a little too much. The other members will, in all probability, resent the UK’s attempts to have the benefits of membership without any of the required commitment, negotiations for British access to the EU markets are sure to be difficult and petulant. We can expect much grandstanding from the twenty-six capitals as each government tries to take a hard-line, to convince their own voting public that they are standing up to the UK. This will result in endless rumours and fake positions, with the resulting disruption to the markets being very hard to manage in terms of investment strategies.
In parallel, there is the position of the multi-national corporations in the financial sector to be taken into account. Although there is unlikely to be a cataclysmic departure of major firms from the UK, nevertheless there will be some global corporates who will transfer at least some of their operations into a country that is still an EU member, Ireland and a newly independent Scotland being two obvious easy moves for a UK based multi-national.. Each such announcement will bring out the pessimists in force, frightening investors with their pronouncements of doom and gloom. While it will, undoubtedly, be overblown - all major companies, especially those in the financial services sector, will want to remain in the UK and to be part of the City of London, which will remain a major global financial centre irrespective of the people’s in-out decision – nevertheless it is the value fluctuations because of this uncertainty that will be the problem.
We can expect sustained turbulence in the market throughout this period. As the rest of the world gets to grips with the idea of a Britain going it alone, the pound would be exposed to speculators, and interest rates could head in any direction, depending on the mood of the market.
The Governor of the Bank of England, Mark Carney, has defined the role of the Bank as ensuring that inflation remains on target and ensuring financial stability. Yet, rightly, he has not commented upon how the BOE will manage this although his recent speech stating the BOE’s belief that overall the UK economy has benefited from membership would indicate that they foresee economic difficulties in the event of a withdrawal.
The volatility due to uncertainty should dampen down once the outlines of the EU/UK agreement emerge. One would imagine that this should lead to a period of calm in the markets and that their movement would be more predictable and based on purely economic factors. However, this line of thought reckons without the possibility of Act Three of Brexit, for it could also have major internal UK constitutional implications. The most likely one would occur in the event of Scotland voting to remain within the EU, whilst the rest of the UK votes to leave. The Scottish National Party has indicated very clearly that this is likely to be seen by them as a trigger for a new referendum on Scottish independence.
In this scenario, the UK would be plunging straight from one controversial referendum, and its aftershocks, into another. A second Scottish independence referendum would throw up all the arguments from the previous one, with the difference that the EU this time around could well be far more sympathetic to the SNPs wishes to become an independent country within the EU than they were the first time out. The warnings about how difficult it would be to join the club may melt away in the heat of the members’ indignation about their rejection by the UK.
Similarly, those large corporations that threatened to decamp from Edinburgh in the first referendum might well switch sides and start pushing for Scotland to go for independence and re-enter the EU. They may see it as an easy way to retain access to a single market that would still remain, post-Brexit, one of the largest markets on the planet.
All of this is without even attempting to have a stab at working out the likely effect in Northern Ireland, whose devolved government is supported by both the UK and Irish governments. The fact that the Irish government would remain within the EU whilst the United Kingdom would now be outside would make the peace process far more difficult to sustain. As this is the UK’s only land border, it would also require significant work to deal with the issues that would suddenly arise there.
Amidst all this change and confusion, whither are the capital and equities markets? The fact is that the raising of all these constitutional issues, and the uncertainty of the outcome, will cause major volatility in the market. The one thing long-term investors dislike is lack of stability and when such fundamental re-alignments of countries and markets are in progress, they will likely steer clear of investing in the UK in a big way.
The economic data will also be uncertain, as the basis on which it is operating shifts in line with the changes in the economic unit being measured. As a simple example, unemployment rates are higher in Scotland than in England, so if Scotland were to leave, some of the UK’s fundamentals would automatically improve post Scotland’s departure.
Others would deteriorate no doubt, and Morgan Stanley’s recent report predicts a slowdown in growth to such an extent that the government would be forced into stimulus measures to get it back on track. Even some fundamentals that we take for granted, like the ever-rising housing market in London, could well take a hit, if the amount of foreign investment were to drop, as it would if London became somewhat less desirable a tax residence once outside the EU area.
None of this augurs well for the investment strategies of standard retail investors. In fact it would not be understating it to say that the investment outlook looks likely to be turbulent for the next while, and this turbulence could even last for the next three or four years, if we are really unlucky.
Searching for safehavens
Investors will need to look for safe-havens that are unlikely to be hit by speculators, havens that are less responsive to political and constitutional stimulus. In particular, those requiring access to their money between now and 2020 would do well to consider avoiding anything associated with the UK at all, in terms of stocks and bonds, as the volatility of the market could play havoc with their plans.
All of this does not even begin to consider the ramifications of the actual UK/EU association agreement that emerges post referendum or exactly how Scotland, if it departs, and the rest of the UK would in effect split the assets and liabilities of the 300-year union. Like any divorce there would be no real winners but the likely effect is that both sides would end up poorer than they were when they started.
Investors are in for a very rocky ride.
What do you think Brexit means for the investment markets? Let us know in the comments below!