This article is an extract taken from the upcoming Forager June 2016 Quarterly Report.
Three times in the past 12 months financial markets have been in a tizz. We went close to a bear market in August 2015, officially entered one in February of this year and then saw frantic currency and equity selloffs after the Brits voted to leave the European Union in the final week of June.
The first two of those were buying opportunities. There didn’t seem to be a lot of rational logic behind some of the selling, and we were able to pick up businesses like Alphabet and South32 at very attractive prices.
It may yet become irrational, but so far the response to the latter, Brexit, has been orderly and appropriate. This is not jumping at shadows. Brexit has the potential to have a very serious impact on the wider UK economy and many of the companies operating within it.
Irrespective of your view on the politics (I have some sympathy for a country wanting less political interference from a supra-national body), the economics of Brexit range between not great and bad.
The optimists’ argument goes that, while the EU allows free trade within its borders, it is actually quite protectionist against the rest of the world. This is true, as any Australian farmer can tell you (some 70% of European farm receipts are government subsidies, compared with just 4% in Australia). Freed from those shackles, the UK will become a rich bastion of free trade with the rest of the world.
The world these people live in, where countries run around signing free-trade agreements willy-nilly, is not the one I have been living in for the past four decades. Domestic politics and self-interest make individual free-trade deals almost impossible to negotiate. The Trans-Pacific Partnership between 12 Pacific Ring counties including Australia, Japan and the US has been seven years in the making, has been dramatically watered down from original expectations and still hasn’t been ratified by respective governments. The proposed Transatlantic Trade and Investment Partnership between the US and Europe was first proposed in 1990 and is still no chance of being finalised. While Canada’s agreement with the EU, often proposed as the template for the UK, took seven years to negotiate and also still hasn’t been ratified. Even in Britain, I’m not sure unfettered free trade is what the average person is in favour of – particularly those who voted in favour of Brexit.
The argument the UK will be better off outside the EU is nonsense. The UK has been one of the largest beneficiaries since joining the European Economic Community in 1973. According to a recent article in the Financial Times, the UK has gone from being the “sick man of Europe”, where GDP per head had previously grown roughly half as quickly as it had in Germany, France and Italy to a point in 2013 where Britain became “more prosperous than the average of the three other large European economies for the first time since 1965”.
From an economic perspective at least, open access to one third of the global economy, which the UK has with its current membership of the EU, is about as good as it gets.
For all of these reasons, I still think the most likely post-Brexit outcome is something that looks largely similar to the current arrangements. Some commentators have even suggested a precedent for a second referendum if new arrangements can be negotiated that allow Britain to stay in the EU with some restrictions on immigration. Or an arrangement similar to that which Norway has where, in exchange for unfettered access to export markets, it agrees to be bound by most EU rules, contributes to the EU budget and accepts unlimited immigration from other EU countries.
All of that is still highly uncertain. Both the governing Tory party and the main opposition Labour Party are in complete disarray in the UK, so no one even knows who is going to be doing the negotiating. And European leaders have expressed contempt for any agreement which might incentivise other countries to go down a similar path.
Even if the ultimate outcome is a positive one, the route from today’s disarray to a happy place is going to be tumultuous. The prospect of exit is going to have an immediate impact on consumer spending, business investment and (probably) house prices. How much is anyone’s guess, but these risks are real and worth treading carefully around.
Hence we have been giving a lot of thought to these risks as we assess our portfolio exposures to the UK economy and the opportunities that are thrown up as stock prices fall. We have direct exposure in the International Shares Fund and indirect exposure through GBST and Enero in the Australian Shares Fund. But we are also concerned about the broader implications of a general trend towards rising protectionism around the world.
A hit to global trade has been one of the key factors in our risk exposure analysis for the past few years, but we have generally focused on exposure to the overall level of trade. This is obviously a heightened risk with Britain leaving the EU, but there are potential further consequences of a rise in global nationalism that need to be contemplated.
We own a lot of European businesses that are predominantly focused on international exports (El.En., Kapsch, Rosenbauer, B&C Speakers, Rolls Royce). These companies – particularly the first four – are massive beneficiaries of the EU project. How did a Linz-based fire truck manufacturer, or a medical device manufacturer based in Florence, become global leaders in their fields?
The answer is that, despite being from small cities, they have free and unfettered access to 500 million potential customers and the world’s largest economy in the EU. The EU also has the ability to use its leverage to negotiate access to other large markets like the US, and these companies become immediate beneficiaries. What chance is tiny Austria of negotiating an equivalent deal with dozens of other countries? The much-derided rules of the EU also govern things like public tenders, ensuring the process is open, transparent and less susceptible to vested interests. What chance is Kapsch of winning a toll road contract in Bulgaria in a world without these rules?
I’m not for a moment pretending the EU is perfect and there are fundamental flaws that need to be fixed. Hopefully Brexit is the wake-up call needed to remedy some of those flaws. But on balance the European project has been an extraordinary economic success story over the past 50 years and some of the companies we own are specific beneficiaries.
A far right candidate, Norbert Hofer, came within a whisker of winning the presidency of Austria in May this year and National Front’s Marine Le Pen is expected to be prominent in next year’s French presidential election. Both are keen on putting up physical and economic borders. From an investment perspective, their desire to unravel Europe’s integration, and the public’s desire to support them, is something we need to be contemplating.
As I have pointed out many times in the past, there is no correlation between economic growth and stock market returns. Our job is to build portfolios that are resilient to a wide range of potential outcomes. And the best opportunities always arise when the fellow investors are at their most pessimistic. So do not think such turmoil would not be without opportunity. But we have some very interesting years ahead of us and it would seem we are going to earn our keep.
17 thoughts on “Brexit Sends the World into a Tizz”
I could be completely wrong, but the Tories certainly don’t look in disarray when compared with some of our locals ! I don’t follow it closely, but they appear to have a depth of talent that is lacking over here. Theresa May certainly comes across as competent, with some pundits comparing her to Angela Merkel.
I think Steve you seem to have fallen into just looking at the impact on the UK, and have ignored the impact on the EU and its remaining individual members. In other words you seem to have presumed the EU and the individual member nations will ‘sail along’ without the UK. You have also ignored the potential gains for the UK from being free to trade globally without the EU shackles (which is really what they are if you just think about its diverse memberships economies).
Some things to consider
1. The immediate falls on the DAX (7%), CAC-40 in Paris (8.4%), MIB in Milan (11%), IBEX 35 in Madrid (12.5%) were much greater than the FTSE (4.2%) – that is saying something. Look at the recovery period and what has happened to them since and its saying that even louder.
2. The worlds tariffs since 1973 when the EU began have dropped dramatically since then (refer the WTO website) so the whole notion of high tariffs restricting global ‘free trade’ while still important is not quite the impediment it used to be.
3. Look at the company tax rates of the UK (20% aiming for 15% if Osborne remains at the helm of Treasury) compared to some of the EU nations Germany 29.72%, France 33.3%, Austria 25%, Belgium 33.99%, Italy 31.4%, Spain 25%, Greece 29%. That is a big driver of corporate decisions. You can add to that other measures such as regulatory ‘red tape’, labour laws etc., to see that perhaps the UK is not such a bad place to have a company.
4. The EU itself will be undergoing some major ‘restructuring’ without the UK, and I would surmise that what the UK has done will be looked upon more favourably than not by most of those countries populations. National sovereignty is not an easy thing for a nations population to give up without a ‘fight’.
5. You have ignored the major challenges the common EU currency faces given the economic variety among its members. Greece gave us (and continues to do so) a foretaste but it would seem Italy will provide the next challenge.
6. The UK is a mercantile nation – small island with global trading power. They are good negotiators and dealers.
7. Many of the current EU member nations have major economic problems which being part of the EU in some ways has exacerbated – youth unemployment is a disaster (50% in Spain for example), work hours/culture/restrictive labour laws in countries like Greece and France for example provide no solution. A 2013 Global study by UBS showed the French work 1480 hours pa with 27 days annual holiday compared to the UK with 1782 hours pa and 20 days annual holiday. Where would you establish your business? Just google up the US tyre company that came to this realisation a few years ago.
8. I’m sure there are many more things that can be said which would counter your surprisingly dogmatic assertions Steve that Brexit will be very negative for the UK.
I’d suggest the UK is where you should be looking for value investments, especially if there’s any link to Australia who must surely be a real potential beneficiary just as we lost out when the UK joined the EU in 1973.
Perhaps the UK could reflect on its famous bard:
There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our ventures.
Julius Caesar Act 4, scene 3, 218–224
Is this such a tide for the UK?
Fortunately the riding of that tide does not require the killing of a good friend (as was the case with Brutus) but merely an amicable divorce (as is the case with Brexit).
Perhaps William Blake’s little poem now encapsulated in the anthem Jerusalem has some prophetic undertones more appealing to the Brexiteers.
“And did those feet in ancient time,
Walk upon Englands mountains green:
And was the holy Lamb of God,
On Englands pleasant pastures seen!
And did the Countenance Divine,
Shine forth upon our clouded hills?
And was Jerusalem builded here,
Among these dark Satanic Mills?
Bring me my Bow of burning gold;
Bring me my Arrows of desire:
Bring me my Spear: O clouds unfold!
Bring me my Chariot of fire!
I will not cease from Mental Fight,
Nor shall my Sword sleep in my hand:
Till we have built Jerusalem,
In Englands green & pleasant Land”
Love the poetry gentlemen but unfortunately for Australia we are left with EE Cummings “A politician is an arse upon which everyone has sat except a man”.
I think the Brexit folk are delusional about the UK’s prospects without access to the Tariff Free EU market. Yes the UK will survive and prosper but not for a decade during which they will enter a recession / depression which will give them unemployment north of 20%. The cost and time to redirect trading relationships / dealers / distributors / customers is not overnight. These were built over many many years and will take just as long to replace. This is before we look at the lost investment from the rest of the world a large number who choose the UK because it is competitive but also because of the access to the EU market.
So the UK must maintain access to this market and the price is unfettered movement of people and paying the EU club fee while accepting the bulk of EU regulation. Which is about where they are now plus they have a seat at the table. Why does anyone think the UK will be given a discount to this club ? The EU will not do anything which encourages others to leave. If you want an example of EU negotiation just look at Greece with it’s referendum rejecting the bailout. They were rewarded with harsher terms. Failure to achieve this access will cost Europe and the UK but simple maths tell us that the UK cost as a %age of GDP will be much higher. (435m market loses 65m market and 65m market loses 435m market) who hurts most as a %age of GDP ?
So what is to be done. While there are a large number of people who voted for Brexit and will at any cost they are certainly not the majority and the best way to see Brexit is a protest vote gone wrong. On that basis I don’t think there is the political will to exit at any price and the price will be determined by the EU not the UK. Given the lack of will then I think the result is going to be a fudge over many years which has it’s costs but ends at much the same place but with less UK influence in Europe. Not a clever outcome.
As for the poetry above. It’s this sort of sentimental crap which got us into this position. Mostly older people who still think being born British is the luckiest thing to ever happen to them and wonder why the rest of the world doesn’t share this view.
Personally I’d push for a 2nd referendum. We are standing at the Abyss and said we would jump. Do we really want to ? This comes from “A measure twice cut once approach” and is not undemocratic and is not about not accepting a democratic decision but ensuring that democracy works. I’d expect a turnout in excess of 80% and it must have “Remains” greater than the “Leaves” in the first vote to overturn it. The reason I’d push for this is the fudging and negotiation and uncertainty has a cost which would be better to avoid.
PS There was only one thing worse than Brexit that week and that was losing to Iceland. LOL
I’d rather that England lost to Iceland every time than see the kind of disarray in the UK that we’ve witnessed in the last fortnight. Nor would I willingly swap any one of the likely candidates in the Tory party for the former Prime Minister. Agree with you re the poetry…sentimental tripe.
Hopefully – given that the UK is a representative democracy, and not a direct one – parliament may decide to vote on the country’s future relationship with the EU with greater collective wisdom than party leaders and the electorate. Since the ‘Leavers’ are such great believers in the primacy of the United Kingdom’s parliamentary sovereignty, I am sure that they will have little problem if MPs vote contrary to their wishes.
Fortunately many people value political freedom and sovereignty more highly than money. What a world where the dollars rule.
As to regarding poetry and drama as sentimental crap, amazing.
One of the major lessons from the GFC, and also the corporate collapses of the early 2000’s, was the insular nature of education for financial and legal professionals.
They were so caught up with ‘chasing the dollar and the deal and loophole’ that they missed out on distinguishing right from wrong.
A little bit of Shakespeare for starters would ‘prick the bubble’ of their schemings. A little bit of history would not go astray in understanding why the Brexiteers voted as they did. To think this is about older people hankering for the past glories of Britain is perhaps more indicative of someone needing to broaden their education on the EU, the UK and Europe for starters.
Fortunately the inate human desire for self betterment, in a system where self realisation can flourish, trumps the melodrama of patriotism, tribalism and notions self-proclaimed exceptionalism. Ie, sometimes the “dollar ruling” aint such a bad thing.
I lived in the UK for around six years, and I found the levels of financial and economic illiteracy to be absolutely mind-blowing. Even finance professionals struggled to comprehend universally accepted economic truisms.
As such, even though Brexit came as a huge surprise to me, it shouldn’t have: the benefits of EU membership are not patently obvious to the average boob, whilst the loss of chest-thumping British sovereignty and scaremongering “journalism” (i.e., BS) about immigrants taking British jobs and eating British swans (cf. http://www.dailymail.co.uk/news/article-1261044/Slaughter-swans-As-carcasses-pile-crude-camps-built-river-banks-residents-frightened-visit-park-Peterborough.html) is a much easier sell.
Nevertheless, I am not convinced that the effect of Brexit on the listed businesses of the LSE will be as bad as the effect on the broader British economy, and there are certain to be many businesses that will be unaffected, or even prosper.
I used the recent pessimism to pick up some shares in a highly illiquid stock called Brainjuicer Plc, which is basically at the cutting edge of where market research meets psychology. I figured that although the cross border movement of goods is likely to be crimped by the rise of protectionism, the sale of B2B services should be almost unaffected.
We have already seen this phenomenon play out in India, where under stultifying over-regulation, over taxation, corruption, and misguided protectionism, the Indian economy adapted itself to become the world leader in outsourced services.
Whenever those in power (in this case, the people) suddenly wrench the tiller of an economy one way or the other, it is the job of an investor to look into the ripples. Hidden amid the ensuing chaos and value-destruction, there are always winners. In times like this, it pays to ignore the obvious and focus on the nuances.
Another example of this: post 9/11 investors dumped Autogrill SpA, which operated restaurant concessions in airports around the world. The thinking was that people would stop flying, and that the extra security in airports would increase Autogrill’s costs. The reality was that people only stopped flying for short while but the permanently beefed up security meant that people would take much much longer to get from the carpark to the restaurants, which meant that they arrived hungrier, which meant that they spent far more. 9/11 was a short-term crisis, and a long-term uber-windfall for Autogrill.
Unfortunately, the TPPA was never about free trade. It was about US dominance of a Pacific axis of Western or Western-like countries. A Pacific version of TTIP, an identical agreement targeting Europe.
Concerning the UK and EU, the UK has benefited hugely from access to the European market since 1973. However, a significant proportion of the UK population has effectively zero idea how economies work and therefore have no concept of what a UK departure from the EU means. If they feel poor now, they’ve got more down the track.
There are concerns that even the legal/regulative aspects of a UK exit won’t be completed for many years.
All this volatility provides plenty of opportunity for those who can take advantage. Unfortunately this excludes 99% of the UK population.
Thanks for the piece Steve.
A common misconception, even among the world’s political and financial elites is that the economic impact of accessing a market for exports is somehow more beneficial than opening up one’s own market to imports.
There is some quite elegant economic analysis that demonstrates that the two are actually much the same. It is not possible for a government to engineer an asymmetric payoff through a treaty that governs trade between a large number of market participants operating at arm’s length.
The only instances that I can think of, where one “government” successfully used free trade to dominate and impoverish another were 1. when the British East India Company took control of India (the only time in history that a private profit making corporation has governed a country), and it specifically designed its trade treaties to act as de facto financial siphons to take wealth from India to the officers of the EIC and by taxation to the British crown (EIC shareholders only saw a small proportion of this wealth filter down to them), and 2. when the EIC defeated China in the First Opium War in order to force the free sale of EIC opium to Chinese citizens – which predictably enough turned China into a nation of addicts.
You won’t hear Brett Stevenson making comment slike that.
Too right, to many of the comments above Anon.
Here’s a great quote from Britain’s former Bank of England governor Mervyn King (which hits the nail on the head regarding Brexit I reckon) when he said: “Trust in money can only work if it goes with sovereignty.”
He was talking in the context of the EU, and effectively saying you need national sovereignty to maintain a currency.
This is why the push is for greater political integration at the EU.
The Brexiteers saw this more clearly than many of the so-called financial experts. If ever you want living proof of Mervyn Kings assessment just look at Greece. I would have thought a currency is reflective to a large degree of the economic strength and stability of a nation. Ask yourself what do the economies of say Greece and Germany or The Netherlands have in common to suggest that the Euro is reflective of their individual economies. That is the problem.
I would have thought a key foundation of value investing is to look at the long term rather than short term implications. Part of this means looking at the risks involved with the foundations of the EU, and especially evident with the Euro.
The UK has made a good decision for their future.
Yes well you’ll get no argument from me the the Euro has been a disaster, and has undermined the EU to a higher degree than perhaps anything else. Rather than being of benefit to all, to has created a zero-sum outcome of winners and losers. The greatest winner, being Germany, and the greatest losers being southern European countries and Ireland.
But of course, this is a distinct issue from the tone of your various posts, which suggests the root of the issue is cultural differences etc. I don’t accept that Germany’s improved competitiveness, since the construction of the Euro, has been a result of its “prudence, thrift and hard work”, any more than I accept that Britain should leave the EU purely because it is inherently “special”.
These cliches and notions are as easy on the intellect as they are popular, and as they are plain wrong.
It’s not so long ago that much of the intelligentsia were making claims about the inability of the Chinese to create successful market economies, because their culture, with its roots in Confucianism, was inherently unsuited to such.
It is not just the great-unwashed that can be misguided and irrational.
Angela Merkel can keep promulgating the virtues of German hard work all she likes, but it won’t change reality. The sad thing is that these notions re so seductively “intuitive”, that even many Southern Europeans believe them and are steadfast in their resolve to hold onto the Euro.
Anyone who thinks a shop keeper in Athens, a farmer in Calabria, or a wine maker in La Rioja, is culturally programmed to be lazy, frankly needs to get out more.
I tend to agree Anon, and your comments on cultural differences and their reflection in the economic strengths of countries is certainly cause for reflection even though I don’t completely agree.
It’s easier to talk in generalities when speaking of cultural influences than in specifics because of the danger of the truth of your last sentence.
However, cultures are influential.
Lets use Greece and France as examples. They have had predominantly left/socialist leaning governments for the last 70 years or so. That has had a big influence on the populace and their expectations of government and work/economy etc (think of the large public service in both countries and the associated inefficiencies, and the phenomenal debt/welfare burden that they have, think of the agricultural sector in France which is pretty much so protected that it is almost impossible to reform, just look at the retirement ages between Germany and Greece to get a very quick gauge) along with the commensurate burdens on private enterprise and entrepreneurial drive.
If I were to establish a company or business (be as a national or from ‘outside’) it’s hard not to consider the macro economic environment and cultural background in a country.
Usually this is reflected in tax rates, HR laws and welfare burden etc. I would give both these countries a big miss on that basis alone.
I’ve just been involved in establishing a business in Canada, and apart from having the same language and laid back culture, their business ‘friendliness’ (low tax rates, less restrictive HR laws/regulations etc) and conservative economic approach on managing the nations finances, are factors which weighed heavily with us.
I think a sovereign nation is a more sensible way to resolve the matter than to paper over the national differences and think all is well. Let Greece go back to the drachma and sort out its own economy rather than being ‘propped up’ and ‘dictated to’ by the EU Commission in Brussels (which in reality is Merkel from Germany eh?). As the Brexiteers so well express it let it be an amicable divorce and then let them be good friends and neighbours as sovereign nations. The UK has set them a good example (even if it does come from a position of strength).
I’m not being as simplistic as to suggest culture will not have an influence. What I’m saying is that it is far less influential than what the usual suspects (patriots, nationalists, chest-beaters, and other simpletons) would have you think.
It is far from being the primary driver. Because whatever culture might dictate, the basic drivers of human behaviour are unchanged. Humans will react to incentives in much the same way.
As to your comments about Greece, ironically it is these very incentives, that have driven its current predicament (sure, likely, aggravated by cultural factors). Do you think it is a coincidence that trade deficits and debt ballooned in sync with the creation of the Euro? In fact, the ballooning of the Greek public service and various generous welfare provisions, were given oxygen by easy credit from Euro partners.
As to your constant harping on about “stability”, I really am unclear as to what you mean. Yes, we have seen the instability in Greece, due to the severe (draconian?) austerity. Hardly surprising though (regardless of whether its merited or not). Frankly, considering the severity of austerity in various quarters (mainly southern Europe), the lack of instability is what is conspicuous.
But Greece is one country. Various countries in your favourite punching bag of Southern Europe have undergone very substantial and painful reforms. But reform in these countries alone will not fix the imbalances in the Euro zone. Now it is time for your favoured northerners, especially Germany, to implement some reforms, or the Euro project, and thus the EU, is in serious trouble.