Brexit: a long and winding road

It’s been a volatile few weeks in the markets following the decision by UK voters to leave the European Union, so here’s a quick reminder of how events have panned out since that historic day, and how Quilter Cheviot has positioned client portfolios.

Currency markets took the biggest strain in the immediate aftermath of the vote with the pound/ US dollar rate falling by around 13 per cent since 24 June.

That proved hugely beneficial for major US dollar earners – such as Glaxo, British American Tobacco and Unilever – driving their share prices to new highs for the year on the back of currency-induced earnings upgrades.

By contrast, the sharp fall in stock markets on the day of 24 June was mainly driven by the lurch down in domestic cyclicals (principally housebuilders, property companies and UK banks).

Will we see further measures to stimulate more direct demand in the Autumn Statement?

These have since recovered some of their losses (housebuilders have risen by 30 per cent since their 24 June low, while selected banks have risen by 20 per cent over the same time period) on the belief that investors’ initial view of a severe UK recession following the vote has probably been overdone.

Meanwhile, Bank of England Governor, Mark Carney, delivered on his promise that ‘the bank would ‘not hesitate to take additional measures as required…’

Those ‘additional measures’ came in the form of a 0.25 per cent interest rate cut coupled with a £70bn package of quantitative easing, sending the price of UK Gilts even higher, with 10 year bonds now yielding around 0.6 per cent.

An interesting additional move was the newly introduced Term Lending Programme which was Carney’s attempt to ensure that interest rate cuts for Joe Public mean interest rate cuts, making sure the supply of credit doesn’t dry up.

The problem with the idea is it addresses the supply side of the economy but not demand. Will we see further measures to stimulate more direct demand in the Autumn Statement? Possibly.

Lies, damned lies, and statistics

Initial numbers, so far, have centred principally on forward looking PMI (Purchasing Managers Index) surveys for the construction, manufacturing and service sectors.

Whichever way you look at them, they make pretty grim reading – all of them signalling a level consistent with a recession. However, we should stress they are surveys, not actual hard data.

And other surveys haven’t been quite as downbeat. July’s CBI Growth Indicator, for example, points to an easing in growth rather than an outright contraction.

It could be, as research from Capital Economics suggests, that responses going forward are less gloomy once the ‘shock factor’ of a ‘Leave’ vote has diminished. UK retail sales for the month of July showed Britons are still buying plenty of barbecues and other summer goodies rather than worrying about Brexit.

Who’s negotiating what?

At least we have a new government in place to negotiate our departure from the EU. But the task of reaching agreement on new trade deals once Article 50 is triggered is Herculean and the process, we believe, could take up to a decade to unfold. That makes visibility on the prospects for the UK economy poor, which impacts, crucially, investment decisions for UK boardrooms.

Does anything meaningful happen in the short term? For the time being, the issue of Brexit may even have to be put on the back-burner.

The events leading up to Brexit should not be seen in isolation, but as part of a wider trend in global disaffection. Tired of real wage reduction, large swathes of the population have turned their backs on austerity, embracing instead anti-elitism and nationalism.

This is evidenced in the rise of Trump and the rise of the far right in France and Germany (bear in mind both have elections next year). These geopolitical events could have serious implications for the path of the US dollar and US Treasuries and equity markets would not be immune.

Good-bye austerity, hello fiscal stimulus?

Even though Mr Carney has resorted to more quantitative easing (QE), commentators are increasingly questioning the efficacy of this type of stimulus, especially in relation to the lack of direct impact on the consumer.

The most common form of direct stimulus being talked about in markets currently is possible infrastructure spend but this approach is not without contention.

Changing dynamics

If the government decides to initiate fiscal stimulus this could change the dynamics of the bond market in particular. The intention, to bolster nominal GDP, will almost certainly lead to a rise in inflation which is anathema to bond investors so the perception of long-term safe havens could be challenged.

Significant parts of the equity market – so-called ‘bond proxies’ which are reliable dividend payers - have also been boosted by the rally in fixed income so any sell-off in bonds would have important implications for stocks as well.

We will be paying close attention to these and other themes as the long road to Brexit gradually unfolds.

Richard Carter is fixed interest specialist at Quilter Cheviot