“And you all know security is mortal’s chiefest enemy”
Shakespeare (Hecate in Macbeth)
Three weeks ago we woke to the biggest political and economic upheaval for decades. Many, like me, thought the country would vote for the status quo of continued EU membership. We didn’t. Instead, the people of Britain took a leap into the unknown and, in doing so, lost their Prime Minister and Chancellor.
We Brits are generally known for our political stability. Extremism has rarely found root in the UK. Nassim Taleb, in his book “Antifragile”, argues that this stability makes us especially vulnerable when the storms are really blowing hard, which is probably why the UK Political Uncertainty index (see Chart A) leapt to a record 664 for June. To put this in context, the index average for the UK is just 141 and ratings for Germany, France and Italy, the three biggest economies in the Euro Area, have never been remotely close to 664.
Markets detest uncertainty, which is why the pound and UK share prices dropped like stones in the immediate aftermath of the Brexit vote.
We now have a new Prime Minister and a new Cabinet. The markets seem to like Theresa May as share prices, and the pound, have rallied. Our new PM has shown that she is no political novice. David Davis, long-time euro sceptic, gets the job of negotiating our exit from the EU. If he screws up, it will fall on the head of a leading “out” campaigner. There are other clever appointments, but the most inspired is probably giving Boris the job of Foreign Secretary where he is likely to come into contact with people about whom he has said some pretty derogatory things (eg., saying Hillary Clinton had “... dyed blonde hair and pouty lips, and a steely blue stare, like a sadistic nurse in a mental hospital") and where he will be kept overseas and out of mischief (no opportunity to repeat his ambush of the last PM from the murky shadows outside of Cabinet) for a lot of the time. As Foreign Secretary, he will have to “own” the Brexit negotiations with the EU and make good on the assurances he gave about the UK’s new relationship with Europe.
The new incumbent of 10 Downing Street directed her inaugural address to ordinary working class families that do not believe they have benefited from globalisation and feel that their politicians in London are out of touch with the needs of the other regions, especially the North. The reason that people like me got our predictions on Brexit wrong was because we thought the discussion and debate would be all about the economy. Wrong! It turned into an opportunity for those that feel disenfranchised from the benefits of free trade, globalisation and the EU to have a say.
So far, Mrs May’s performance has been impeccable. She seems to understand the divide in the country and she has made some drastic, and clever, changes to the Cabinet. In fact, the markets like her so much that there was no need for Mark Carney and the Bank of England to reduce base rates yesterday, much to the surprise of many. But this is no time for complacency.
The world’s focus will soon be shifting from the UK to the Italian banking crisis, which is unresolvable within existing EU regulations. If Italy’s banks fall, so will their young PM Matteo Renzi. The election campaign for the 45th President of the US will start in the Autumn (it’s likely to be a bloody battle), and in 2017 there are major elections in France and Germany, where the nationalist parties will hope that they can do to the Franco-German stability what UKIP did to ours. It is not over yet!
The corollary of Shakespeare’s claim that “security is mortal’s chiefest enemy” is that insecurity can be beneficial, as claimed by Nassim Taleb. Let’s hope so. In any event, we are hedging and diversifying risk wherever we can. This is no time to be bullish.
There are many potential benefits being outside the EU, but the price we must pay is short-term volatility. The challenge for Britain is; to take advantage of a lower pound which makes our goods and services more competitive in foreign markets, engage those that feel disenfranchised from the benefits of globalisation, maintain the benefit to the economy of immigration whilst making our borders more secure and get on with much needed infrastructure projects, such as an additional London runway and new trans-Pennine links. All this would need to be achieved whilst controlling public finances and keeping confidence in the markets. Would I want Theresa May’s job? Not on your life!
Gary Reynolds CFA ACII DipPFS IMC Chartered FCSI
Chief Investment Officer
Transcript of Video:
Market Response to Theresa May's Appointment as UK Prime MinisterThe markets liked the appointment of Theresa May. They liked it a lot. The pound recovered, the FTSE 100 went up, and the general sentiment was that this is very, very positive. Now, this is a honeymoon period for her, and that's a wonderful endorsement of her appointment by the markets. But just to put it in context - it couldn't have got much worse could it? We had carnage politically in this country but the short term response has been good, and I think that is because she is seen as a competent politician that does the detail, is industrious and hard-working, and straight-talking. That is the type of person you're going to need for what is probably going to be four of the most demanding years for any UK PM for decades.
Economic Implications of The New CabinetOn the whole the market likes Theresa May's new cabinet. There were some surprises, there were some appointments that were to be expected. But I think the thing that is most impressive about the new PM's decisions is that it looks like she's thinking longer term. She's thinking longer term I think for the benefit of the country and she's thinking longer term politically. So putting David Davis, an ardent and long term euro sceptic in charge of negotiating the UK's exit from the EU, means that if it all goes hopelessly wrong it falls on to the out campaigners. Putting Boris Johnson in the Foreign Office, also another out campaigner, who will be involved in different degrees with those negotiations, means that he's got to ensure that the promises he gave that there will be a better life for the UK, outside of the EU, are realised. And that means that Mrs May as a remain campaigner can always shift that blame if things go wrong onto the out campaigners. Now I don't blame her one jot for doing that because one of the issues I had with the campaign for leaving the EU, was that it never really addressed the nitty gritty of the issues. It was fought mainly on sovereignty and immigration. But the truth is, what is the effect on the economy if we lose access to the free trade in Europe? And if there is a hit on the economy, we're all going to be poorer for it. So it needs to be negotiated in some detail now, and we need to start thinking about how these decisions affect the economy on a day-to-day basis.
UK Interest Rates - Why No Change?In markets I think the actions tell you a lot more than the noise. So I thought it was likely that Carney and the Monetary Policy Committee (the ‘MPC’) would cut rates this week. The fact that they didn't is because they had seen that the short term panic wasn't as bad as expected. And in fact there were positive responses to having a PM in place, because remember before Leadsom stood down there was uncertainty about who would be the new PM and when they would be appointed. So that cleared up straight away once Theresa May got appointed, and the market response was very positive. So I think the MPC. was able to catch their breath and think, 'do we really need to cut rates or not?' and if they don't have to they won't. And the reason is simply that rate cuts of a quarter percent are not going to make very much difference, and there's not much left for them to cut after that - do we go to zero? Do we go negative? So I think they've done the right thing - it gives them a few weeks, they'll take another decision next month. But it does mean short term that, at least as far as the Bank of England is concerned, things were looking a lot better at their meeting than they were in the weeks leading up to it.
Confidence Outside the UKI think we're generally unpopular amongst other EU members, at least the people that are in charge. I think they now accept that this is just a problem that's going to be dealt with, but I think the way in which the rest of the EU - because we are still currently a member - sees the UK, is not in the way we see the risks. We see the risks from a failure of the economy, that you either get a one-off hit where we perhaps lose 2-3% of GDP (Gross Domestic Product) and then go back to a normal rate of growth. Or we have a reduced rate of growth for a long period, or, and what is probably the biggest risk for the EU is that we don't have a reduction in GDP, but our rate of growth actually accelerates. What that will do is probably finish the EU off, because it will give the confidence and the courage for other EU members to ditch the federalisation experiment and want a completely new negotiation. So the way in which European leaders look at us at the moment - if you gave them the choice, I dare say a lot of them would be delighted if we hit recession with rising unemployment, because it would deter the other members from taking a similar path to the UK.
Global RisksThere are a lot of risks in the world at the moment. Now I hasten to say before anybody looks at this and gets thoroughly depressed after I talk about what's coming up over the next year, that there is an old saying that "the markets climb a wall of worry". There is always something bothering us, and possibly the thing that should always bother us the most is when we haven't got much to be bothered about. Because that's when confidence is riding high. You know as Shakespeare writes in Macbeth, "security is mortal's chiefest enemy". Put it another way - pride comes before a fall. When you're not looking for the risks, that's when you are most at risk of walking into something that's devastating. So, one could be optimistic on the basis that there are so many things to worry about. Italy's banking system which was never cleaned up after the 2008 credit crisis, is in a mess, and because EU rules prohibit governments from bailing out their banks unless the bondholders have taken a hit, Renzi, Italy's PM - because Italian bank bonds are held by ordinary Italian savers, can't under the current EU rules bail out his own banking system without hitting ordinary Italian savers, which will cost him his premiership. So I suspect you've got a fudge coming on that one pretty quick. Then we've got the election of a new US president, with both Hillary Clinton and Trump lurching towards protectionism. If that happens then that's going to dent free trade which is going to make the whole world a little poorer. And then next year we've got major elections in France and Germany, and in France certainly there's a resurgence of support for Le Pen and the Front National, and it won't have been lost on the French that in the polls they disliked the EU even more than we did. So if they had a referendum the chances are France would jump the way we've gone by a bigger margin. Now that may be a good or bad thing economically in the long term depending on your perspective, but it is certainly going to cause some short term turmoil. But there is some decent news around. The US economy is doing reasonably well. Core inflation is above 2% in the US, and has been for some time, and it's beginning to look like perhaps we are getting to a point when this long term low interest rate period will come to an end. It will come to an end because economies are picking up which will be very good for investors who will be able to look forward to getting better term returns on their money in the future. However, if you're holding long bonds, beware, because as those interest rates shift, you're going to take a pasting on your bond price.
Courtiers Portfolio Performance and Investment Approach
This is the most difficult time for running client money. Political risk is off the scale in terms of the complexities it creates for us as analysts and asset managers. So, we constantly look at the outcomes. I always think it’s very important to look with your eyes and listen with your ears to what's happening on the market on a day by day basis, but alongside that we use some quite sophisticated models which can create stresses of different things happening. So we were running a double stress test coming up to the referendum. One was Brexit limited contagion, one was Brexit with wider contagion. We knew there would be short term hits to asset prices in Brexit either way, and it happened. We covered that off because we believed the dollar would be safer and would rise in value against the pound, and on the Friday that the referendum happened, our portfolios went up in value. That was great. So we're keen to try and engage the next risks coming up, with strategies that can help get our clients' assets through them. But whilst we're doing all that we've got to be mindful of the fact that, what if the world navigates its way through these problems? Well, what if new inventions and productivity suddenly starts to kick in again? You've got hundreds of years of evidence showing that mankind is an extraordinarily innovative race that will keep creating new tools and new services in an ever-improving fashion. What if all this happens and what if then share prices go up a lot? If we're overly cautious we miss the rise. If we're overly optimistic we get hit by the downs. But that's what running money is all about. In the end when its times like this, you don't take big bets. You diversify as much as you possibly can, you cover off wherever and whenever you can, and you keep the portfolio so that it will benefit from rising prices, and that is what we will be doing for the rest of the summer.
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