Two years ago Analysts/Consulting Owen Evans presented a seminar for clients entitled Fun with Vertical Fiscal imbalances. A core message was that Australian Governments had effectively no clue as to the extent revenues would fall as a result of the mining boom, and that we were in for a lengthy period of declining living standards. The response, Owen said, was that government would increasingly be confined to short terms and instability would become the norm. Let’s look at some facts that have emerged since then.
By a relatively large majority, UK voters elected via referendum to leave the EU. This was clearly a surprise to most commentators and markets, with Sterling and global equities markets getting thrashed on the day, the PM announcing his resignation (to take place by October) and roughly half the Labour Party front bench resigning. Watching it live was like watching lemmings jump into the sea below, a feeling exacerbated when the most interesting commentator turned out to be Lindsay Lohan. Here are a few observations:
The short-term economic implications for the UK and Europe are clearly negative. The longer-term implications are also negative but may not be overtly visible. One must presume that global GDP growth falls very slightly over the next two years because of this. One also must conclude that interest rates are likely to stay lower for longer; and,
The direct impact on Australia and Australian listed companies is likely to be imperceptible. But there may be a small bias in favour of domestic-related businesses as opposed to exporters and interest rate sensitive stocks. There is certainly no reason to think that Brexit will hasten a global economic recovery and for that reason, there is no rush to return to investing in mining and resources related industries.
The Brexit debacle was immediately followed by Australian voters demonstrating a significant swing toward a union leader from a Government roundly rejected by voters in 2013. Preferring heart over head, Australia will probably end up with a hung parliament and a Senate controlled by individuals who variously want to ban live cattle exports (thereby effectively killing the NT economy), subsidise Tasmanian electricity generation and reintroduce financial transactions taxes, reintroduce tariffs that will increase the price of goods for everyone, and based on petitions of just 200,000 people, introduce rolling referendums to decide laws. If you think that is kooky, consider that by the end of the year a boorish reality TV star could be the next US President;
These seemingly outcomes are both seemingly bizarre and based on a well-honed ignorance of what matters.
Western prosperity since 1946 has been based to a large degree on growth in trade, personal freedom and mobility, and increasing economic integration. The days of having three different electricity outlet types in the UK and 35 in Europe have been coming to an end. Brexit is a vote against trade, against mobility and against integration. In effect, 17m Britons voted for an immediate pay cut. It seems unlikely that they would have done that, if they understood the impact. The fact that two of the main proponents of Brexit have now stood down, suggests a total lack of belief in the BS they were peddling.
First, this is an unexpected outcome and following issues with US polling during the primaries it calls into question the capacity of western leaders to understand what exactly it is their constituents want or expect from Government. Instead of making and delivering on policy Governments are deliberately pandering to interest groups/issues, because:
- there is no point in trying to convince rusted-on supporters and;
- because of the mistrust and pressures linked to a decline in living standards, we are living in a time where people are relying on their feelings for guidance, rather than education or logic.
- Add to this the internet which is enabling democracy by popular engagement, with the consequence that many people have plenty to say, but not much knowledge about what they are saying.
- Across the west we have an ageing population increasingly fearful of the impact of immigration. It is borne of a nationalistic fervour and a desire to build barriers against all manner of perceived threats (but immigration in particular).
A basic tenet of economics is that what is good for the population is not necessarily good for the individual. Combined with the inability to measure voting intentions accurately combined with a willingness to vote against perceived self-interest (even if it is the general interest) suggests that unusual political outcomes may have become standard. As a result of these factors, the gridlock that hampers decision making in many Governments is set to become more serious.
As we have said countless times in Client newsletters, we have entered a time of extended volatility and uncertainty and we are experienced in managing that. This experience is critical when the main alternative to investing in markets is to put your money in the bank. Interest rates of below 2 percent are about a third of the income generating capacity of most of the portfolios we build. The choice to put your money in the bank ensures you lock in very low-interest rates, and that you are eating into an increased amount of your savings, just for day to day expenses.
In terms of the market outlook, Brexit will likely see markets unstable for a while. But they were already unstable, and the portfolios we have built for clients have shown good results in withstanding that. As we have said in Client newsletters, interest rates are unlikely to increase anytime soon, and in general that is good for the portfolios we build.
Given the trade advantages of the EU, we will be amazed if the long term outcome is not that the UK struck a deal with the EU such that most if not all of the primary economic advantages were retained, but that the UK exerted more control over its borders. In this context, its worth noting that Norway subscribes to almost all of the EU rules, thereby retaining trade benefits, but without being a member (of course, it gets no say on how those rules are formed).
Overall, our view is that we are in for a very long period of sub-trend global growth and this will continue to result in global economic and social instability. For many years there will be no free kicks and the rewards will go to those who can look beyond the emotion. We believe that is the most valuable service that we can offer clients.
Originally published in our July 2016 newsletter, read more recent newsletters here.