Brexit is the leading edge of a wave of change

Managing Director & CIO20 Sep 2016

Investors struggle with politics. Analysts who usually have a razor sharp focus on the detail of company reporting can sometimes miss the big picture. But the question that should be asked of the Brexit vote is “why?” It is too easy to think simply at a stock level, or even about just the UK economy. More powerful global political forces may be at work.

Revising beliefs is difficult. But it would be wrong to dismiss the Referendum result as simply euroscepticism – a movement with echoes in many EU member states. Instead, the underlying driving force seems truly international; mirrored in current US politics and in a new nationalism that runs across the BRICs. In many Western countries, real living standards for the majority of the population have not improved in more than a decade. New political movements and emerging populists are now harnessing this frustration. And blame is falling on the people and policies that have delivered a perceived stagnation. It matters little that technology may have improved quality of life, or that the leaders of the Western world have pulled the global economy from the brink of the abyss after the Great Financial Crisis. People can only take so much austerity.

For institutional investors, this is an uncomfortable message. But there is danger in dismissing what seems irrational. The culprits of this failure are seen as globalisation, the financial sector and the political elite. The last category seems to include almost any expert who opines on the value of monetary policy. Cutting interest rates to zero is meant to boost confidence, but to the public it is a sign that central bankers are a bit worried. The consumer behaviour it triggers is save more, spend less. Financial assets may have been helped by bond buying and competitive devaluations, but that does not impress the average voter around the world. Seen in this light, Britain’s new nationalism may simply be part of a trend that has already taken root in Japan, India and Russia. So far, it has worked for Trump, too.

Revising beliefs is difficult.  But it would be wrong to dismiss the Referendum result as simply euroscepticism

There may be more surprises for investors as new governments focus more on fiscal policy and wealth distribution. But the biggest challenge could be a change in direction of travel for the global economy. Markets may need to accept a reversal of the trend to globalisation with increasing trade and bigger multi-nationals. That would cut world growth and bring in more specific country risk. Many investment managers have for so long based their investment strategy on global convergence, that this will require a radical rethink.

Unfortunately, the bill for the borrowing boom that led up to the crisis has grown. Banks in Italy and Germany have made little attempt to deleverage in the way that US banks have. The major British ones are somewhere in the middle – still risky, but without the level of systemic sovereign linkage seen in the Eurozone. The European Banking Authority stress tests due July 29th are designed for no bank to fail. But it is questionable whether this sort of fudge will boost confidence in the sector.

No economic policy seems able to deliver inflation

No economic policy seems able to deliver inflation; the one thing that is needed to deal with bank debts in Europe if write-downs are not made. This downward pressure on prices globally appears driven by lack of productivity improvement - not helped by the failure of most economies to make productive capital investment. Politicians claim to see opportunities in infrastructure, but China and India bear testimony to the difficulty of making good investment decisions by public planning. Money printing has made funds available in the West, but much has gone into property and share buy-backs.

With the help of QE, investors have found that shares can make money in a tough environment. But voters need genuine economic growth – not gains from property and shares. Many of today’s investors are from the “lucky” generation that has seen peace, prosperity, property ownership and savings for retirement. Their challenge now is to see geopolitics from others’ perspective. Brexit may just be a signal of bigger economic change to come.

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