“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” – Winston Churchill
The end of the beginning
Blundering around in the dark of that ever unknowable future, feeling around for any clues of what is to come, we routinely exaggerate the importance of the lumps and bumps that our fumbling hands come across. We probably need to keep this, the inductive fallacy, in mind as we try to divine the future from the tea leaves of both Prime Minister May’s ‘Dear John letter’ to the EU, and the aborted attempt to repeal and replace the Affordable Healthcare Act (ACA). For capital markets investors, the advice remains the same – tune much of this out and focus on a global economic backdrop where still-rising private sector optimism will soon be followed by perkier hard economic data and corporate profits in our view.
Brexit negotiations will no doubt be arduous and more besides, but much pessimism is already reflected in sterling, while the UK (and the world’s) capital markets tend to dance to the tunes played by the global economy, as we’ve regularly pointed out. At the end of it, with or without an agreement, the UK will likely remain an island that enjoys a very benign democracy, first class institutions and a world-respected rule of law – qualities not to be underestimated in the battle to attract global investment flows. A slightly more closed economy, which seems to be how the government has interpreted the referendum result, will likely be a little less dynamic in time, and therefore should, all things being equal, suffer a slightly lower trend growth rate.
However, as noted above, we shouldn’t exaggerate the importance of what we think we know now. Our guess remains unchanged from February of last year – Brexit will provide a headwind for the UK economy, but a digestible one. Nearer term there is some likely transitory inflation for the consumer to digest, and investment may dip while so much of the UK’s future relationship with the EU remains unknown. However, that brisker global economic backdrop, with continental Europe very much participating, may help paper over some of those cracks. With regards to the negotiations, it is probably worth remembering that on the European side of the table there surely has to be explicit downside to not being a member of their club; simple self-preservation demands it. On the other hand, it is likely not in Europe’s best interests to decimate a major trading partner either. It is this balance – not the Prime Minister’s carefully worded letter – that will be the dominant factor in the negotiations to come in our view.
For the US, we would also be wary of reading too much into the aborted (first) attempt by House Republicans to repeal and replace the ACA. Many have argued that this moment represents the death knell for the ‘Reflation trade/Trump bump’ – if Congress can’t push through legislation that they’ve spent seven years preparing for, what can they do? The pro-business agenda of this new administration has run into the congressional treacle already. The Freedom Caucus – obdurate opponents throughout the Obama presidency – do not seem to have mellowed under Republican leadership as some had hoped. To some this would suggest that the surge in regional and mid- and small-cap business confidence surveys, assumed to be precariously dependent on the enactment of the president’s agenda, will soon tumble back to earth. However, at the national level, the confidence surveys have risen in tandem with those around the world. This synchronised surge in private sector confidence actually predates the US elections and ironically dates back to around the time of the UK’s referendum on its EU membership – a time when most in the world were predicting an entirely different, and much darker, near future for the world economy.
As with every week, we urge readers to keep an open mind. Strident predictions have little place in the world of investing, even if they do help grab precious marketing air. The world economy is warming up, there will no doubt be plenty of twists and turns to digest, but equities still look well set to continue to outperform bonds. Continental European, US and emerging equities are the areas we would focus on.