Defying Gravity…

…And you can’t pull me down!

For those who have seen the musical Wicked, you may recognise the lyrics. I have not seen it but my wife and daughters have and, having bought the soundtrack and played it non-stop during the summer driving through France and Spain, I now know the songs just as well.

Every time I hear or read about market performance and particularly the FTSE 100 climbing through 7,000 points, I can hear this song playing in the back of mind. It does feel like markets are defying gravity; so what can ‘pull them down’?

It does not take one long to assemble a list of events that might cause markets to correct. Theresa May’s inference of a ‘hard’ Brexit, one which sacrifices access to the single market to take back control of immigration, has caused the pound to tumble further.  A loss of confidence in the UK will eventually take its toll on the share prices of domestic firms, particularly the banks.

Despite the release of damning, if not exactly surprising, evidence of Donald Trump’s opinion of women, he remains well supported and has a chance of becoming president. His economic plans do not appear to add up and whilst he is at the extreme, he sadly represents a growing disillusionment with globalisation in the western world and a move back towards nationalism and protectionism.

Britain fired the starting gun in Europe by voting to leave the EU, but most countries have well supported Nationalist parties. There are difficult elections looming in France and Germany where the notion of free trade and free movement of people will come under threat. Add to this the continued troubles in the Middle East, the continued slowdown in China, a potential monetary tightening in the US and the headwinds against equities begin to mount.

Dividend paying shares, particularly those with a good track record, are in high demand.

What is driving markets however is the fact that 8 years on from the crisis, interest rates remain at historic lows. Couple this with slow GDP growth and investors search for yield drives up the price of any asset which is generating an income. Thanks to quantitative easing, it now costs investors to lend to Western governments; corporate bonds prices are at all-time highs as the search for yield moves up the risk scale.

High yield bonds have historically low yields, forcing investors to hold more and more equity in the quest for an income. Dividend paying shares, particularly those with a good track record, are in high demand. This effect has been turbo-charged in the UK as companies paying Dollar or Euro dividends look even more valuable given Sterling’s decline.

This disconnect between the wider political and economic climate and the fundamentals driving markets could continue for some time. Even if the US eventually raise interest rates, there will continue to be a dearth of income yielding assets which should continue to support equity markets.

The headwinds are likely to ensure that even if markets avoid a fall down to earth, we could be in for a bumpy ride. The positive in this situation is that volatility provides investment opportunities and whilst on the lookout for these our investment managers are also keeping portfolios well diversified. Having exposure to foreign currencies may yet provide further returns as Mrs May begins our journey out of the EU.

It is important therefore to hold your nerve and not be tempted to time the market. Diversification has made sure portfolios have benefited from non-sterling exposure and that same diversification should soften the landing if markets fall. If you have any questions or concerns, please do get in touch.

Brexit – “Should I stay or should I go?”

What Brexit will mean if we decide to ‘leave’ or ‘remain’

With just days to go until one of the most important decisions in a generation, we thought we would add to the mountains of commentary on the vote. Greenstone does not have a house view on which way people should vote and therefore this missive is not to sway opinion one way or another, rather to offer comment on the claims and look ahead to what the landscape might be on 24th June.

 

The case for Leave (“If I go there will be trouble…”)

This is clearly the more vocal of the campaigns; one cannot help noticing the number of posters encouraging us to vote out. Their central case seems to revolve around three pillars; regulation, sovereignty and immigration. The belief is that if we were to leave the EU, we would be able to take control of our own destiny and cut the red tape which is holding British business back. It would also allow us to negotiate trade deals with the rest of the world which would boost exports and reduce our trade deficit.

The subject of immigration dominates debates however and is a key issue for the leave campaign. Many in the UK remember the claims regarding tens of thousands arriving from Poland and the new joiners in 2004 and the resulting 1million+ which came over has made many cynical of future immigration claims. The fact that the Polish in particular have integrated well into society and particularly the economy, seems a given but irrelevant for their argument. The fact is we had no control over the inflows.

 

The case for Remain (“…And if I stay it will be double”?)

As with the Scottish referendum, campaigning for the status quo is hardly the most inspiring message. It has been dominated by fear of the unknown and tales of perilous economic hardships if we leave. Their message is that the EU is a long way from perfect, but it is a case of better the devil you know. They also point out that it is better to be involved and try to reform it from within than sit on the side lines, still being affected by its decisions but having no say.

Whilst not saying that the UK is a lesser economic and military power than it used to be, it talks up the virtues of collective bargaining and that being part of a group of 500 million people adds weight at international negotiations. The main argument however surrounds the economy and the belief that a Brexit will curb demand of UK services, particularly in the financial sector, which are vital to our economy.

 

How to decide?

The problem with such an important decision is that it effects so much, it is impossible to quantify the costs and benefits of either option. There is more clarity around what a remain vote will bring, as effectively there will be little change. However, in our view the arguments for voting for or against are as follows:

Remain – You believe the EU has been good for Britain, Europe and the World. That the UK is stronger when working closely with our neighbours and there is better opportunity for trade by remaining part of the Single Market. The overriding reason however may be fear of the unknown or shorter term market volatility.

Leave – You believe the EU has not been good for Britain, that the EU’s free movement of people has caused a strain on housing and public services. That we are better off trading with the rest of the world and remain a big enough power to command bilateral trade agreements with India, China and the US. The overriding factor may be that you are concerned about immigration and wish to restore sovereignty.

 

Myths, half-truths and unknown unknowns

As we mentioned, it is nigh on impossible to say what the specific costs and benefits may be of either vote given that membership of the EU affects so many parts of our lives. Both camps have been guilty of making claims backed up with little evidence or worse, ignoring statements and official opinions of professional bodies.

As mentioned, the remain camp has been based largely on scaremongering and they have employed some ludicrously exact claims of a cost of exit. There was a precise figure of how much worse-off households will be in over a decade’s time, that unfortunately mixed up household income and national income per household. There were also figures on the increased cost of one’s holiday to Tuscany this year!

The leave campaign has had its share of questionable statistics, though its main tactic has simply been to ignore the official voices. Almost all financial and business institutions, from company owners to banks, central banks and organisations such as the IMF, have said Britain is better off in the EU. The leave campaign has simply retorted ‘they would say that, wouldn’t they’.   This appears to be an effective argument as a large portion of the population is mistrusting of such official opinions. It has allowed the leave campaign to claim that there will be less immigration, even though most of our immigration comes from outside the EU; that it would stop Brussels setting so many new laws despite the fact that new legislation is largely home grown; and that we can have a trade deal with the US despite the American President himself denying such a claim.

 

What will 24th June look like?

Whilst it is easy to become caught up in the hype, come the morning of the 24th June, the sun will rise, people will go to work as usual and England will no doubt be heading for an early exit from the Euros. It will be in the days, months and years that follow in which the true repercussions emerge. Below are what we think might occur in the weeks that follow either result.

 

Brexit – The FTSE 100 is likely to fall sharply as markets wake up to the news that uncertainty remains. The pound will also likely fall against most other currencies, though the fall against the Euro may be tempered by the Euro’s own fall in value as the EU as a whole looks less attractive to investors minus Britain.

It is likely that David Cameron would resign and as the party elects a new leader, gilts may come under pressure as international investors weigh up Britain’s economic future. This in turn would push up the cost of borrowing and could trigger a recession.

Longer term of course, we may negotiate a number of bilateral agreements with the rest of the world, allow only the best and brightest into the UK and cut red tape for business, generating a highly productive, exporting economy and a shrinking welfare bill, leading in turn to lower taxes. Of course, a vote to leave would still need to be approved by parliament and, although unlikely, it could be blocked if enough pro-EU MPs were prepared to go against the public will.

 

Remain – There may be a small relief rally in markets and Sterling could strengthen against major currencies. If it is a close vote there could still be a vote of no-confidence in the Prime Minister, putting pressure on gilts, but that is less likely. The housing boom may well resume as foreign investors who paused their purchasing plans start buying again. There may even be a bounce in GDP as companies deploy investment which they have held back in new machinery, marketing and employment.

Over the longer term the risk is that there is a wave of immigration which we cannot control and therefore puts further strain on welfare and public services. It may also be that increasing involvement from Brussels affects the competitiveness of our industry and service sectors which, combined with the pressure on the welfare state and increased taxes, tips the country into recession.

 

Conclusion

Over the longer term, no one can say which vote will lead to the most successful result.   It is too big a decision with too many outcomes. We believe the vote will be much closer than the bookmakers would have people believe and the result is likely to come down to turnout. Those who will vote no matter what are more likely to be pro-leave, whereas the remain voters tend to be younger and more apathetic.

We continue to live in interesting times.