Brexit 2016: A FinSec Comment

Britain’s immediate political turmoil is significant. The Prime Minister, David Cameron has resigned and the MPs (the majority of whom backed the remain case) now have to implement the leave case and what deal they will push for. A part agreement with continued free movement and budget contributions (Norwegian style) or complete separation – will they even have a choice? The UK Government is expected to ratify the referendum decision before invoking Article 50 of the Lisbon Treaty informing the EU of the decision to leave and commencing exit negotiations. It seems to confirm that there is no real post-Brexit plan.

Brexit has created a number of challenges for the EU, with the fear of contagion top of mind. With the UK setting a precedent for leaving, there are concerns a large member like Spain or France will also consider a similar move. While leaving would be much more difficult for these countries, which are tied into the EU through the currency bloc, some commentators wonder whether the EU will try to “punish” the UK in negotiations to send a clear message to other prospective leavers.

With the resignation of The Prime Minister, David Cameron, many across the globe have taken to Facebook to express their views on what will happen next…

Source: Internet Meme, original photo CNN

The nature of Britain’s trading relations with the EU will not become clear until late 2018 at the earliest. There is little doubt the decision will have, at least in the short-term, a negative impact on political and financial stability in the UK.

• This instability will see a decrease in consumer and business confidence. Naturally investors and businesses will delay putting money into Britain and many existing investors may move their investments to other countries.

• A weaker pound could boost exports but also raises the cost of imports (e.g. oil) which in the short-term could be detrimental to their already large account deficit. Trade volumes to and from the UK may also be disrupted while future terms are negotiated over the next two years. Even longer given trade deals between the US and the EU took three years alone.

• A weaker pound will also lead to higher inflation and either wages (and therefore cost of business) will rise or wages won’t rise and living standards will be eroded. Yes, ironically a leave campaign fuelled by voter anger over squeezed living standards could result in a further squeeze to those living standards.

• The UK financial sector has traditionally held a dominant position in Europe and is likely to lose this with Brexit. Its status as an international financial hub is also likely to be negatively impacted with some international finance companies already threatening to remove staff.

The Leave side promised supporters both a thriving economy and control over immigration. But Britons cannot have that outcome just by voting for it. By rejecting free movement across it’s borders they reject the benefit’s that come with the EU’s single market, both economic and lifestyle driven. What will become of the 1.3 million Britons (statistic courtesy of the United Nations) residing and working in the EU? Will the UK see a wave of repatriated retirees, unproductive but in need of pensions and health care needs? More stress for what could likely be, an already stressed economy.

Just like Y2K, Bird Flu, Swine Flu, Grexit, US debt default, Ebola, Grexit again the world is full of key events and phenomena that our financial markets are hinged upon. Brexit is the latest and will certainly not be the last. If the Brexit leave vote is confirmed, a full exit will require hundreds of pieces of legislation and administrative steps that will will be played out in years, not days. In that time other more pressing issues are likely to hijack headlines.

As part of the global community, Australia can expect to see some direct negative impact from Brexit, though at this stage, they are anticipated to be relatively small.

• In the short-medium term markets will be chaotic, there will be a lot of noise and we should expect heightened volatility and uncertainty.

• Australian exports to the UK are minimal, representing 1.5% of total exports, whereas the UK represents 8% of Australian services exports. This suggests tourism may see a larger impact compared to other Australian sectors. That said, the Australian banking sector is heavily exposed to the UK and Eurozone and is likely to face challenges over the Brexit transition.

• The impending Australia-EU Free-Trade Agreement becomes more complicated and at the same time less attractive.

• There is a possibility for lower growth in commodities demand in the UK and elsewhere that will translate to lower commodity prices this will have a negative impact on Australia which is still resources-driven.

• While Europe settles there could be some encouragement for Australian’s if international investors look to markets outside of the Euro region as they seek less volatility.

• The Reserve Bank of Australia (RBA) has indicated in previous meetings that it may cut the official cash rate further this year. In light of increased global volatility from Brexit, it looks likely the RBA will continue with this. A cut to the Australian cash rate should encourage business investment (through lower costs to borrowing and investing), in turn supporting the local economy.

• It is possible that we will see a new wave of UK migrants to Australia as those in the stay camp throw their hands in the air and leave the mother country.

There is no need for ‘knee-jerk’ reactions when the mechanics for a British exit and their implications on markets are so unclear at this stage. Rather, events such as Brexit highlight the value of having a well-structured diversified portfolio and the need for ‘buffers and shock absorbers’, built in specifically for circumstances such as these.

This said, the leave vote has certainly taken us all by surprise. Here at FinSec we have been exploring a number of European opportunities that will certainly require a new perspective now… Our advice; look through the short-term noise, there will be plenty of opportunities thrown up for our fund managers as investment markets become oversold.

We will keep you informed as the situation progresses.

Brexit marks a new era for the EU and the UK, and volatility is likely to continue while the transition occurs. The actions of the EU and UK in managing the next stages of this will be crucial to understanding the impact to these regions and to investment markets. Interesting and uncertain times ahead for the world. As we approach our own Federal Election this weekend one ponders the vagaries of democracy and the unpredictability of populist politics.