Richard Buxton: The hard facts on a soft Brexit

Investor discipline is required more than ever when political emotions are running high


Politically, we are a nation divided. Young against old. Haves against have-nots. Remainers against Brexiteers. The electorate has never been so disaffected. Forget balanced budgets and a hard Brexit; it seems now is the time for a new government to adopt a more redistributive mantle. Whether it does so with Theresa May at the helm remains to be seen.

But while political emotions run high, as investors we are required to be more disciplined.

The reactions of both the internationally oriented FTSE 100 index and its smaller, more domestically focused counterpart the FTSE 250 following the general election result were both measured and logical.

And while pundits had proclaimed that any political upsets would unfold in the currency markets, sterling’s fall against the US dollar was contained. A far cry from the plunge seen on the night of the Brexit vote.

Inevitably, the slight softening in the pound against the greenback favoured the share prices of the big international resource stocks of the FTSE 100 – the likes of Glencore and Rio Tinto.

Yet, at a fundamental level, the prices of mining stocks have been dictated far more by upward revisions to earnings estimates rather than any swings in currency markets. After all, earnings trajectories are what really matter to investors.

That said, investors have been scratching their heads over the behaviour of bonds and equities for some time now. The pull-back in bond yields would suggest some macroeconomic weakness. The bond market appears to have given up all hope that President Donald Trump will be able to deliver anything in the way of tax reform or fiscal stimulus package to help pick up any economic slack.

By contrast, the current levels of global equity markets, standing near to all-time highs, would suggest that profits growth is still forthcoming and the economic outlook benign.

And what of the behaviour of bond proxies: the likes of Unilever, British American Tobacco, and Reckitt Benckiser? Those FTSE stalwarts which produce strong and stable profits (where have we heard those words before?) year in, year out, irrespective of the economic cycle?

While the debate between the merits of bond proxies versus economically sensitive stocks will doubtless rumble on, we know that some things rarely alter.

We know that the sentiment towards UK banks will only change for the better once interest rates are on a gently rising path. The actions of the US Federal Reserve, and the likelihood of a third hike, should help in this respect. Here in the UK, interest rates will not rise as long as the uncertainty over Brexit negotiations prevails. Witness the difference in share price performance of dollar-sensitive HSBC against pure sterling-exposed Lloyds.

We know that the dynamics of the housing market mirror industry fundamentals rather than the short-term plight of the UK consumer. Here is a sector that has been driven by capital discipline and clever landbank purchases.

We also know that the fortunes of the consumer-facing stocks will be much more data dependent going forward, as investors focus on which way the current softness in consumer spending goes next. Rising inflation and anaemic wage growth are not an easy combination for the UK consumer to digest.

So, back to those all-important Brexit talks. While the negotiations themselves may well be delayed, the clear message from the young is that a hard Brexit is not for them. Without the mandate for the hard Brexit she sought, May will surely have to work towards a softer Brexit, or extended transitional arrangements? A pull-back from the threat of a “no deal” Brexit abyss should put a floor under sterling for the time being.

Investors must retain a sense of perspective. Near term, the outlook is relatively healthy. Global trade is picking up, European consumption is gathering momentum and Asian companies are riding a wave of corporate upgrades on the back of an uptick in economic activity.

But longer term, storm clouds could well gather over the UK. The result of the election might mean that a fiercely redistributive government is possible at some point.

Excess labour worldwide and the disinflationary impact of technological change make it hard for central banks to generate any inflation, even if they want to. Arguably, for too long, we have seen capital rewarded at the expense of labour. That tide is already beginning to turn, with gradual rises in the minimum wage.

But add the probability of future fiscal policies to the mix and, some years out, we could see the return of both significant wage and price inflation.

Those under 35 are the first generation to face the prospect of being worse off than their parents. Capitalism is not working for them. With no memory of the disasters of post-war socialist government and runaway inflation, Jeremy Corbyn’s agenda is immensely appealing.

If, at some point in the coming months, UK shares have to price in the end of the post-1979 pro-market policies and a return to a pro-labour, anti-business agenda, then they have a long way to fall.

Richard Buxton is head of UK equities at Old Mutual Global Investors