Brexit – Two weeks on and has the world turned upside down?

Wednesday 13 July 2016

Two weeks after the Brexit vote won the day, finance expert Oliver Stones says there are still more “unknowns than knowns,” although consumer confidence has certainly taken a severe downturn.

Mr Stones is the Fixed Income Investment Director at Quilter Cheviot, and his view is that while it is still too early to tell exactly which way the wind is blowing, the “hysterical hyperbole” which would befall UK PLC, according to ‘remainers,’ clearly hasn’t happened:

“If a week is a long time in politics, then the last two weeks in Westminster have been positively Palaeozoic.

“At least we now know the name of the future UK Prime Minister. Any hard or soft facts like this, in this time of limbo, are clutched at by a needy, uncertain and worried media and population alike.

“Two weeks after the monumental decision to leave the EU the ‘tea leaves are still swirling in the bottom of the tea cup’ with more questions asked than hard answers given.

“But we have now got our first hard answer, our first bit of post-Brexit data in the UK in the name of the UK’s GFK Consumer Confidence survey which showed the worst numbers for 21 years as the 2,000 population sample answered with one extremely unconfident voice.

“This will come as no surprise to anyone, irrespective of their vote to leave or remain but it does seem a tad ironic that the North-east of the UK that was so virulently ‘Leave’ is now the least confident in the UK’s economic future. What happened there?

“What is perhaps worse and embedded in these numbers, is the deeply negative number for expectations for the UK economic situation in 12 months from now. This number at minus 29 is worrying to say the least. No wonder Mark Carney, the Bank of England Governor promised this week for further symbolic interest rate cuts and perhaps more electronic printing of money (Quantitative Easing) to help the UK’s once strong economy survive over some bumpy months and years ahead. But who really is he helping out? Is it you or me? No, it’s mostly the banks.

“As we put away our celebratory ‘Leave’ bunting or lick our ‘Remain’ wounds, one thing is certain - all of the banks need some fairly urgent help. With negative interest rates, low borrowing demand, decreasing profit margins and now super-low consumer confidence (which in-turn translates into lower high street retail sales, lower business investments and thus lower business loan-demand) the UK banks, with over 13.5% average ‘rainy day’ money (Tier 1 capital) are OK for the time being.

“It is the European banks, more specifically the Italian banks, who have hit a cavernous pot-hole in the road. They lack capital to cover their burgeoning loan-loss provision and they have an eye-wateringly large book of non-performing loans. Watch this space, but it would be highly ironic if the Brexit vote has started some systemic mini-banking crisis in Europe from which the UK will certainly not be immune.

“Otherwise much of the hysterical hyperbole of the in and out campaigns have come to nothing. The FT 100 equity market is at August 2015 levels, up 18% from the mid-February lows of this year. Be a bit careful on this one as much of the FT 100 companies are foreign currency-earners and have been helped by Sterling’s fall in value. If we look closer to home such as the more UK-centric FT 250 index, then we can see a 6.5% fall since Brexit, but this fall is hardly precipitous. Markets are generally hysterical, over-reactive drama Queens, but just occasionally they are more rational, pipe-smoking headmaster-like stoics. So far we are happily in the latter camp on asset values but with two notable exceptions; property and the value of Sterling.

“Commercial property funds are attracting some seriously negative media attention as one after another they close their respective doors to business, meaning that investors cannot liquidate their investments. This resonates uncomfortably with the ‘freezing’ of illiquid funds as the precursor to the great global financial crisis (GFC) of 2007/8. But it has some extremely notable differences that are critically important to understand before you charge off to the cellar to eat cold baked beans.

“The property funds have been ‘gated,’ inferring that the gate will swing open again, (for example some have set 28 days as their expectation) once they have assembled enough cash to pay for the sellers. Most importantly and unlike the 2007/8 GFC, the underlying assets are by no means the toxic worthless waste that the frozen funds had as their underlying assets, but respectable and valuable physical bricks and mortar. If you hold a property fund the current inclination held by many is not to panic and weather out what is likely to be a temporary squall.

“That leaves us with the currency market and this remains the deepest and most troubling concern. As the interminable UK/EU legal proceedings rumble on in a way that resembles ‘Jarndyce and Jarndyce’ in Dickens’ ‘Hard Times’ - so the value of Sterling could be constantly devalued. To date we are down 13.5% versus the dollar and down over 30% versus some other G10 currencies. “As a country with a trade deficit, a current account deficit, who manufactures-for-export very little and imports 60% of its foodstuffs, this is desperately bad news. Not only will your holidays abroad be more expensive (goodness knows how much a pizza half way up Mount Blanc now will cost - £45 perhaps?) But also the cost of goods at home will start to rise as imported inflation starts to bite.

“The costs of imports rise, raw materials become more expensive and ‘factory-gate’ prices paid by the consumers have to start to reflect this as the producers’ margins have to be protected at some point (although it is argued that this could cause another round of food pricing-wars amongst the supermarkets). More worryingly it is generally thought that Sterling has at least another 10% devaluation left in it over the next few months.

“So we can see that after two weeks there are still more ‘unknowns’ than ‘knowns,’ but the things we do know are ambiguous with a bias to being ‘worse’ than ‘better’ and this, I suspect, will surprise very few. I will give you an update once we see more ‘water under the bridge’ and more hard facts.”