• Written by 
  • 19/07/2016

“There’s less in this than meets the eye.” (Tallulah Bankhead)

Much of the recent gloom infecting capital markets has been based on a
disproportionate obsession with the UK’s EU referendum, gloom that we expect to eventually disperse as the global economy continues to prove itself less terminally ill than the consensus would have you believe. In the meantime, investors will again need to call upon their stores of composure.

Real returns 3 of 8 Welcome 1 of 8

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The UK voted to leave the EU at the end of June to the immediate horror of financial markets where change is rarely welcome. Some poise has since returned to equity markets, where many have retraced their pre-referendum levels (Figure 1). Safe haven trades such as gold and the highest quality government issues, including that of the UK, have remained well bid nonetheless, suggesting tensions remain elevated.

Purgatory not hell

We urge clients to remain calm and retain our view that the impact of an exit from the EU on the UK economy will be unhelpful but digestible over the medium term. With the UK contributing less than 5% to the world’s output (Figure 2), this period of purgatory for the UK economy should not meaningfully alter the trajectory of the global economy, where steady if unspectacular growth remains our base case.

Those arguing for a return of redenomination risk in Europe may again be underestimating the commitment of its major players to the euro project. Meanwhile, the last few years in particular have surely taught us that the social and political fabric of the European Union can bear a lot more stress than we might have previously imagined.

For investors, the advice remains to stay invested and diversified. A period of uncertainty and volatility is assured, however the prospects for global growth and inflation continue to be underestimated. Bizarre though it might seem to suggest in light of much of the attendant commentary on Brexit, but it may be those prospects for growth and inflation that are still more important for portfolio returns on a 6 – 12 month view.

Campaign trail vs. reality

There can be few hard facts in the debate on the UK’s membership of the EU, as we pointed out back in January’s In Focus (‘Brexhaustion’, 29 January 2016). Neither the costs nor the benefits of UK membership are as easily or accurately quantifiable as the debate has suggested. In the absence of such hard facts, the referendum has been distorted into a choice between implausible extremes, neither of which were ever really on the table – those agitating for an exit from the EU increasingly promised to return the country to the ‘halcyon’ days of the 1970s and before, when the UK still made ‘stuff ’ and public services were uncluttered with migrants. Meanwhile, those urging a vote to remain warned of an immediate recession, widespread job losses and an end to the peace and stability enjoyed by the continent for much of the post-war period if you were foolish enough to ignore their warnings.

Less stark choices

Our suspicion remains that the challenges posed by an exit from the EU are digestible, if probably unhelpful, for the UK economy at this point in time. We very much doubt that politicians on the exit side of the debate will be able to deliver on their promises to ‘give us our country back’, as one voter so succinctly put it. Ultimately, any trade agreement will likely entail regulations and limits on the UK, regardless of whether such deals are negotiated from London, Brussels or anywhere else in the world.

For its part, global trade is well established as a positive sum game for all countries open to it1, but it clearly does not come without both explicit and implicit costs.2 The happy state in which most UK citizens find themselves today, with life expectancy, mortality and morbidity among the indicators continuing to move in the right direction (Figure 3 and 4), is in large part down to our openness to trade. Beneath the hurly burly of the political debate, this is a reality that is not lost on most of the politicians who urged an exit, some of whom simply want ‘sovereignty’ returned so that they can try and exchange it with faster growing nations through trade deals.3

What now?

Our belief that the prospects for global growth and inflation are being materially underestimated by the world’s capital markets remains. If anything, the last few weeks have bolstered that confidence, with US import prices and CPI data both pointing in a similar direction. It is still the US economy, and in particular its consumer, that we look to for clues on what lies ahead for the wider world. May’s personal income and spending data (Figure 5), alongside higher frequency employment indicators (Figure 6), point to robust consumption growth as we look to the second half of the year. The latest manufacturing confidence data also suggested that the effects of the oil capital expenditure downturn and past US dollar strength continue to dissipate.

For Europe, leading indicators (Figure 7) currently also point to brighter times ahead, though we should expect those indicators to be dented, but likely not upended, as the result of the UK’s referendum is digested. Our base case remains that Continental Europe will continue to chug along creating jobs and credit. In this context, continuing to have some exposure to the re ion’s junk credit and equity markets still seems appropriate, particularly in light of the likely supportive posture from the continent’s policymakers.


As of the latest TAA (Tactical Asset Allocation) change, our highest conviction overweight positions in portfolios are US and Continental European equities. Earnings prospects are still being underestimated in both of these regions, in our view, given a little more statistical support by the recent pick-up in the ISM manufacturing (Figure 8). We do not see valuations doing much of the legwork for returns from here, but still expect investors to be well compensated from simply banking (or reinvesting) whatever dividend the corporate sector chooses to pay alongside any intervening growth in that dividend payment. Elsewhere, we do see selected attraction in the junk credit market, as explored in more detail in this publication. More broadly, our belief that the cycle end is inevitable but not imminent continues to inform our advice that investors should remain invested in portfolios diversified across asset classes and geographies, with a continued leaning towards developed equities.


1 Consensus on Economic Issues: A Survey of Republicans, Democrats and Economists – Dan Fuller, Doris Geide Stevenson, 2007
2 Barclays Compass Q2 2016 – Not all that it seems?
3 Free Britain to trade with the world, Financial Times – Daniel Hannan, 21 June 2016