Brexit background – a strategist’s view

banner-graphic-briexit

It is natural to prize social co-operation if, like mine, your country lies more than a metre below sea level. By contrast, islanders may have more mixed opinions on the merits of integration with their neighbours. From an investment strategy perspective, however, our view on Brexit is clear – it will likely lead to weaker sterling and, to a lesser extent, a weaker UK stock market.

An unpromising background

At the turn of the year, our outlook for UK growth was already pretty cautious. At 1.5% to 2.0% our GDP growth expectation was decidedly below consensus and much lower than the forecast from the Bank of England (BoE). Our reasons for caution included the negative impact of several headwinds: fiscal austerity, a slowdown in global growth, and risks around the strength of consumer spending. Since then, both the consensus and the BoE forecast have come down, but we still think they are too high. In fact, we now expect growth to come in at the lower end of our range at 1.5% versus the BoE forecast of 2.2%.

Our main reason for increased caution is the observation that UK growth is now basically firing on one cylinder: consumer spending. Government spending is turning negative, trade is under pressure from the global growth slowdown, corporate investment is weak due to a collapse in earnings (see chart below), and housing is slowly rolling over.

Of course, the consumer is a force to be reckoned with. Consumer spending is a large part of GDP. However, consumer spending, historically, is closely related to the fortunes of the housing market. And with London coming off the boil and construction slowing down, we see the first signs that the market is about to turn negative. In addition, despite unemployment being very low, wage growth has decelerated lately. In any case, we can’t expect consumers to carry all the weight even if they are able to maintain spending. More caution is therefore warranted.

graph-1
The Brexit referendum

Now David Cameron, the prime minister, has done his deal with the European Union (EU). It is up to the British people to decide whether or not they think it provides a strong enough rationale to stay in the union. The referendum to do so is scheduled for the 23rd of June. The decision of Mayor of London, Boris Johnson, to campaign in favour of the out campaign was a setback for the Prime Minister. He is after all the country’s most popular politician. However, it might also turn out to be a blessing in disguise, because Cameron can spin the referendum as a choice between two leaders, and he still has the upper hand in that regard.

The deal itself is largely symbolic. There are a few cosmetic changes such as new standards for welfare benefits for immigrants, but nothing substantial in the relationship between Britain and the EU. The choice at hand is therefore much more about the long-term benefits versus the long-term costs of EU membership. Given the high degree of trade integration, that choice would normally favour a vote to stay in. Also, given the worries around ISIS, the increased cooperation in areas of security and defence over the last decade should help the campaign to stay in. However, the risk is that the vote will not be decided on long-term considerations, but instead turns into a referendum on issues such as the Syrian refugee crisis and high home prices (for which immigration is blamed).

Because of that risk and the uncertainty it entails, we have decided to downgrade our UK business cycle score in our Cycle, Value and Sentiment appraisal process from -0.5 to -1.0. We expect the uncertainty will weigh primarily on the pound and, to a small extent, on UK equity markets. For the gilts market the situation is more balanced, with lower foreign demand pushing yields up and lower expected growth and inflation pulling them down.

Strategy outlook:

We are maintaining our underweight in UK equities. Fixed income investors should keep their expectations low with respect to gilt yields. Without the BoE hiking rates and without a big bounce in the oil price to US$50 per barrel, we expect the yield to move within a relatively narrow range of 1.5% to 2.0%.

Russell Investments will be holding an investment breakfast on Wednesday 27th April at the AMBA Charing Cross Hotel from 0830. To apply for a place, please link here.

Wouter Sturkenboom, Senior Investment Strategist, Portfolio Strategy Group, EMEA

 

Wouter Sturkenboom

  1. No comments yet.
  1. No trackbacks yet.

This blog is not intended for retail investors. The opinions expressed herein are that of Russell Investments, are not a statement of fact, are subject to change and, unless they relates to a specified investment, do not constitute the regulated activity of “advising on investments” for the purposes of the Financial Services and Markets Act 2000.

This material does not constitute an offer or invitation to anyone in any jurisdiction to invest in any Russell product or use any Russell services where such offer or invitation is not lawful, or in which the person making such offer or invitation is not qualified to do so, nor has it been prepared in connection with any such offer or invitation.

Unless otherwise specified, Russell Investments is the source of all data. All information contained in this material is current at the time of issue and, to the best of our knowledge, accurate.

The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

Copyright © Russell Investments 2017. All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

The Russell logo is a trademark and service mark of Russell Investments.

Issued by Russell Investments Limited. Company No. 02086230. Registered in England and Wales with registered office at: Rex House, 10 Regent Street, London SW1Y 4PE. Telephone 020 7024 6000. Authorised and regulated by the Financial Conduct Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS.