What do the referendum results mean for markets, for housebuilders, for currencies? John Stepek chairs our Roundtable discussion.
The UK has voted to leave the European Union. In the process, both of our major political parties have collapsed into leadership battles, politicians across the EU are giving varying views on what will and won’t be allowed, and investors across the globe are struggling to work out just how important Brexit might be, or if it will even happen. Our own view is that, given time, the UK is likely to end up with a Norway-style deal that leaves things mostly as they are, but with the UK less tightly tied to the EU. But what happens to markets in the meantime?
The FTSE 100 took a brief knock, and the FTSE 250 – being more domestically orientated – took a harder one. Sterling has slid to a 31-year low against the US dollar (though it’s not quite as drastic against a broad basket of currencies – the trade-weighted sterling index is hovering around 2013 levels).
But some of the more apocalyptic warnings haven’t yet come true. Pre-Brexit, Chancellor George Osborne warned that borrowing costs would rise as investors attached more of a risk premium to British assets. Yet gilt yields have plunged even further – it now costs Britain less than 1% a year to borrow money for ten years. That suggests that whatever else investors think of Brexit, they don’t deem it inflationary, and they still think that British government debt is a relatively safe place to stick their cash.
As a result, we might see even cheaper mortgages – HSBC put out a two-year fix at 0.99% (albeit with a £1,495 arrangement fee) just before the vote and we could go even lower now, Ray Boulger of John Charcol tells Money Marketing. “Most mortgage lenders did not pass on much of the pre-referendum reductions in rates so we can now expect to see a bit more price competition, especially in the longer-term fixed rates.”
A further slide in mortgage rates also suggests that fears of (or hopes for, depending on your point of view) a major house-price crash might be somewhat exaggerated. In the absence of mortgages becoming more expensive, it’s hard to see what would drive the upsurge in repossessions and fire sales that tends to herald a massive correction. Prices in London were already coming off the boil following stamp-duty changes, but the hefty falls in the share prices of both housebuilders and banks look to be pricing in something rather more dramatic. And it’s not all bad – the weak pound should be good news for domestic tourism and exporters.
Of course, if Brexit results in other countries – eurozone countries specifically – voting to leave the single currency, this would escalate things sharply. If a country is forced to leave the eurozone, that raises the threat of redenomination risk and all the other things that markets spent lots of time fretting about when Greece looked like it might be thrown out of the eurozone.
One hot spot to watch out for is Italy – Bloomberg this week reported that Germany is opposing an attempt by the Italian government to use Brexit as cover for bailing out its troubled banking sector, in contravention of the EU rules on state aid. “The government in Berlin rejects the argument that the UK vote to leave the EU constitutes an ‘exceptional circumstance’ which, under EU basic law, can allow a national government to grant aid to a company outside of the state-aid rules.”
As for the wider equity markets, as John Plender notes in the Financial Times, Brexit certainly increases uncertainty – it’ll take a while to hammer out a deal. But “the normal preconditions for a full-blown bear market are not yet there. Monetary policy around the developed world remains accommodative.” And the reality is that Brexit gives it one more very good reason to stay that way. Markets might not like uncertainty, but they do like loose monetary policy, and amid the highs and lows of the Brexit process, that will be welcomed by investors across the globe.
So what should you be avoiding right now –and what should you be looking to buy? On the following four pages, our Roundtable experts – Dominic Frisby, Max King of Investec, Charlie Morris of The Fleet Street Letter and Tim Price – give their views on what Brexit means for politics, and for the UK economy, and their tips on what to pop into your portfolio.
John Stepek: So Britain’s voted leave. What now?
Max King: Several months ago, I thought the vote would be to leave – but I’ll admit that just before the vote, I also thought I was on the wrong side of that bet. My view, right along, has been that a leave vote would make very little difference to financial markets. I suspect that before long we’ll see sterling back above $1.40, and that we won’t be able to see any real impact in equity markets – or much of an economic impact either.
As for what happens next, I spent several years doing takeover arbitrage and one thing I can tell you is that nobody accepts the first bid. There will be an improved offer. This will, in due course, be followed by a final offer, and a new deal will be put to a second referendum later this year. That’s the way Europe works. They never accept defeat.
They always come back with a second package. If you were in their position, facing all the hassle, work and bother of the EU falling apart, then you’d go for the easy life and offer a much-improved deal too. So I think we’ll have a second referendum, on a much-improved offer from the EU, and Remain will probably win that one.
Tim Price: I accept that the EU model is, “No Ireland, no Denmark, you voted the wrong way, please vote again until you get the decision right”, and that’s been par for the course for years. But if we have a second referendum, I think we would have a civil war in this country. The powers that be threw everything at this. Any institution with an acronym was wheeled out to say the world would end if we voted to leave.
Here in the UK, the political debate went far beyond the bounds of civil argument – the gloves came off early and they never went back on again. And I think that was what alienated so many people. The way to ensure the hostility of the disenfranchised middle and working classes is to talk down to them, patronise them and just bombard them with unsubstantiated facts about their long-term economic future. The UK Treasury is perhaps the single guiltiest party here.
Dominic Frisby: Yes. How much more disenfranchised will those people feel if in six months’ or a year’s time there’s another referendum?
Max: Well, I should add that if the EU doesn’t offer a much better deal to the UK, then it’s not an organisation that we will ever want to be in anyhow.
Charlie Morris: I must admit that a second referendum seems unlikely to me. As for what happens next – we’ve been told that people want facts. But in a social science like economics, there aren’t any facts, only opinions. You get facts from a mechanic or an engineer. From an economist or a politician, you get an opinion. Singapore’s a low-tax country and it’s successful; Sweden’s a high-tax country and it’s successful too – they’re different, but both systems work. So Britain can survive in or out of the EU.
Max: Economic and market experts aren’t experts.
Charlie: Absolutely, and the public knows that. However, what is true is that you’ve had a system in Europe that has really failed for those in southern Europe and for many others – France has created no jobs since 2002, for example. Employment in America, Britain and the rest of the world has hit new highs, whereas in the EU, all the jobs are being created by the northern countries, and particularly by Britain. That’s the reason we’ve had an immigration surge – it’s simply because our system works. So the EU, in my opinion, is a crumbling institution and was going to fail anyway.
And that’s actually what the market is telling you quite clearly. Since the vote, sovereign debt spreads have gone up very significantly in the periphery – the gap between the likes of Italy and Portugal’s cost of borrowing and that of Germany’s has widened. The message from that is that Germany and London will survive, but the European Central Bank will no longer exist.
Max: That’s why they have to offer a better deal – because they simply cannot afford to let the UK go.
Dominic: Yes – this could kick-start a domino effect where Denmark, Holland, Norway, Scotland, potentially Sweden, are all lobbying for their own referenda. Then you’ve got Donald Trump in the US. He’s low in the polls right now, but one thing we should learn is not to underestimate that man.
The message from this referendum is just how unpopular the establishment is, which could affect Hillary Clinton badly. So I think we may be entering an era of political instability, one in which we’ll see a lot more referenda.
Max: Actually, I think one of the problems with the EU in the long run is that people do not want three levels of government. The EU is a device for breaking up nation states. I don’t think it’s a coincidence that Scotland and Catalonia want independence, and Czechoslovakia broke up. The EU is a comfort blanket for regional independence. I think the nation state is much more likely to hold together outside the EU. So I think that actually, if you want to keep the UK together, exit is probably the right answer.
John: So where are the buying opportunities? Or has the market priced in Brexit correctly?
Charlie: From a big-picture perspective, the FTSE 100 is an international index, full of globally diversified earnings. If sterling goes down, it’s always a buy, and the index right now is not expensive.
It’s trading very close to its 18-year average, in fact – the FTSE 100 first touched 5,800 on this morning in 1998, and has spent half its time since at that level.
Meanwhile, the forward-looking dividend is 4%, which is historically attractive. So it’s fine – you could buy it using a Vanguard tracker, such as Vanguard FTSE 100 ETF (LSE: VUKE). I do think it’s bad news for the pound. But it’s even worse for the euro, so the strong US dollar trade is still on for the long run.
There’s been a bit of a vote against domestic Britain – housebuilders have fallen hard. But then, we’ve got a house-price bubble that hasn’t really been resolved; we’ve got a credit bubble that hasn’t really been resolved; and we’ve got bond yields that are extremely low, with nowhere to go apart from a little bit lower – so it’s not surprising that when the system that is trying to prop all of this up and keep the funny money going is torn apart, it suffers.
John: So Britain is already screwed economically?
Charlie: Yes. It’s no more screwed post-Brexit than pre-Brexit – it’s exactly the same. So I think the best bet is to think internationally and buy diversified earning streams.
Tim: Housebuilders have been hit hard because of what drives house prices. High house prices are not down to there being too many people and not enough houses, because rents would reflect that. Instead it’s all about credit. If we haven’t got the ECB and its charming system of infinite money, then credit costs go up.
Dominic: You’d have thought that with the pound being weak it makes all those stupid new-builds more attractive to overseas buyers.
Tim: That’s central London, sure: pound down, Mayfair up.
Max: I think the issue with the housebuilders is that the market believes there will be severe constraints on immigration, and as a result, growth in the number of UK households will slip, and demand will fall, which is bad for householders. But I’m not really sure I buy that, and I certainly don’t think it justifies a 20% share-price slump. So I sort of buy the housebuilders. But the most exaggerated fall is probably within the commercial property sector.
I don’t believe that Britain’s business prospects will be diminished by Brexit, and, as one analyst was saying today, at current prices, you’re discounting London office rental yields of 6%. At a time when bond yields are negligible and falling, that seems a pretty safe buy for any UK-based investor. The obvious one’s a diversified investment trust like TR Property (LSE: TRY), but if you feel brave, buy Land Securities (LSE: LAND) or British Land (LSE: BLND).
Tim: I almost never have a currency opinion, but sterling doesn’t seem expensive here, particularly against the euro. To me, the biggest economic threat around Brexit is not so much the impact of the UK leaving – it’s the potential for a domino effect that leads to the EU breaking up entirely. So there are currencies I’d prefer to own other than the euro. If you think the risk of a potentially systemic shock is non-negligible then trend-following funds are a great way to diversify your portfolio. One option is Man AHL Diversity Alternative. Other than that, value equity is the only game in town.
John: What about gold and gold miners?
Tim: I’m sure readers will be well aware of this argument by now, but gold is relevant – Brexit or not – because we’re living through a potentially existential crisis for the global monetary system. There will come a point when the marginal bond-vigilante investor is just going to say: “Enough of this – we’re just not buying Japanese government bonds at negative yields, which are guaranteed to lose money.” There’s no economic validity to that argument whatsoever.
Charlie: And they’re brewing up a pensions crisis.
Tim: Well, exactly, pension funds are loaded up with this stuff. The equity market is always volatile. It will go where it goes. But there will be biblical amounts of losses attached to bond markets in the short to medium and medium to long term, yet the regulator is asleep at the wheel – it’s encouraging people to buy this stuff, which is deemed low risk, when it’s not.
Charlie: This is way off the topic of the EU, but you know what happened last week that was really important? China’s renminbi made a six-year low.
Tim: Yes, Societe Generale’s Albert Edwards wrote, just before the vote, that sterling would fall with or without Brexit, but the renminbi drop matters more.
Dominic: He got that right.
Charlie: Yes, if China goes down it would be quite a shock to the system. We lost the Nigerian currency last week, after the oil-price collapse put pressure on its dollar peg. The Saudi riyal could be under threat too. China’s going, and you have to wonder about the Hong Kong dollar – I had a good conversation with someone recently who reckoned it was the most over-levered market in the world if you look at the amount of bank activity relative to its size. And there are a few economic indicators there that are going nuts – figures relating to Chinese transactions that have been normal for 20 years then have suddenly dived off in another direction. I’m not quite sure what to make of it, but something’s up.
Max: Going back to shorter-term opportunities, I think you’ve got to be UK-orientated. The FTSE 100 has held up quite well, but the mid-cap FTSE 250 came off sharply. With discounts on investment trusts widening, this is a good time to be picking up small-cap trusts, such as Miton UK Microcap Trust (MINI) or Standard Life UK Smaller Companies (SLS). That apart, my longer-term view for this year is that you should be buying into the healthcare sector, with a fund such as Biotechnology Growth Trust (BIOG).
Dominic: If my theory on increasing political and monetary turmoil is right then you should own some gold, because eventually that turmoil will lead to higher rates and then you’ll get your bond-market crisis. Having said that, when you get a big panic event, gold spikes then tends to give the gains back. So you’ll probably be able to buy gold at $1,250 an ounce or so in a couple of weeks. Bitcoin has also rallied tremendously. It’s extremely volatile, but I think in the longer term it makes sense to own some.
On currencies – I’ve never seen consensus like the current one that sterling is a disaster waiting to happen. But history shows that when sterling goes below $1.40, then if you buy and ride out the volatility, you will make money, because it’s cheap. Against the euro, sterling has to be a buy because the second-biggest economy in Europe is leaving the EU project – that’s got to be euro bearish. And if we get the economic decisions right over the next couple of years – given the opportunity to improve and reduce regulation, and the galvanising of energy across the economy that a vote like this could bring – Britain and the pound could do incredibly well.
Max: I’m not so sure that the political turmoil will be that bad. Charles Gave of Gavekal is a very smart guy, and he has always said that Brexit – which he supported – would lead to turmoil in Europe. But as he also points out: was the breakup of the Soviet Union bearish or bullish for markets? He argues that any political change that results in greater freedom from bureaucracies and socialised government is always bullish. In this context, political turmoil basically means a loosening of control by the elite.
And in the UK – unlike France or Spain or Italy – you’ve got a pretty sensible alternative leader in the form of Boris Johnson. His greatest asset is that the Tory establishment doesn’t like him, which is why he appeals to the country. Then you’ve got a potentially excellent chancellor in Michael Gove. You could put together a first-rate government that would really bring greater economic and political stability to the UK, not less. So my message is: don’t worry about political turmoil in the UK, it will be all right. There are smart people in the wings waiting to take over.
John: On that note, who do you think will be prime minister by the end of the year and who will be leader of the Labour party?
Charlie: Labour, no idea: but “not Corbyn” seems likely. We know he’s anti-EU and in truth I suspect that David Cameron would have been anti-EU had he been a back bencher. On the Conservative side, I don’t think Boris Johnson’s going to be prime minister because he split the party, just as Michael Heseltine never got the job after wielding the knife against Margaret Thatcher. It will be someone who can bring it all together. I’m not sure who that is, but I doubt they’re that prominent at the moment.
Dominic: It could be Stephen Crabb for Tory leader. And I don’t see how Corbyn stays in charge of Labour, given the lack of leadership he’s shown.
Max: I disagree. I think Boris Johnson is the new prime minster. He is the man of the moment and I think it will be disastrous for the Conservative party to turn him down. As for Labour, I think Corbyn will stay. My opinion of him went up enormously during this campaign. He was asked on television whether it was possible to control immigration while in the EU, and he answered: “No.” I thought: “My God, an honest politician.” Then he said that as long as the EU pursues economic policies which keep the poorer countries inside the EU and emerging markets in poverty, immigrants will keep on coming and I thought: “this is a guy who’s utterly honest”.
Charlie: But let’s be honest, he doesn’t have a future.
Max: Not at all – I think that all those people in Labour who bullied him into supporting Remain against the wishes of their core voters – they’re the ones who are in trouble. I don’t agree with Corbyn, but I admire his honesty and his courtesy, so I think he will still be there.
John: House prices this time next year: UK-wide and in London. Up or down?
Charlie: UK-wide not much difference – could be plus or minus 10%. London down. Period London property up a bit, new-build London down a bit.
John: Any impact from Brexit?
Charlie: Maybe it will be accelerated a little, but even the mighty EU can’t defy the laws of gravity. What’s more important is that the property market has been going up every year since 1996, and you’ve had this surge post-2008, particularly in London. So you’ve had a bubble and an event comes along to help pop it – do you blame the event or the bubble?
Dominic: I’d say UK property will be pretty flat overall. Maybe out of London will be up a little bit, period property in London – I just think it’s immune, so up a bit too.
Max: The changes in buy-to-let taxation, restrictions on second homes, and the general drying up of capital flight from emerging markets has already had an effect on UK property prices particularly in London, and I think that will continue. But if you’re a long-term buyer, the next year is probably going to be about as good it gets in terms of timing. It’s not because I can justify house prices. I can just see that, chronically, there are going to be more buyers than sellers in the London market.
Charlie: Well, if it continues to be the capital of Europe, you’re right.
Tim: I have no view – primary residential property is a liability not an asset.
Charlie: Not when we have a monetary system like the current one.