All Aboard the Brexit Big Dipper!

Investing in the UK Pre and Post Brexit

At 04:39 on Friday, 24 June David Dimbleby announced that the BBC forecast was that REMAIN could not now win. Cut to a beaming Nigel Farage at a party somewhere talking about the British people getting their country back.

As the enormity of the news sunk in, a stunned nation (actually four stunned nations) began to emote. The degree of recrimination and acrimony first evident on Friday morning only got worse over the weekend. Facebook almost crashed at times, such was the volume of posts: many of them expressing hurt and apprehension; many giving vent to vile abuse. An old friend of mine spent the Saturday morning unfriending most of his Facebook network. The love-fest at Glastonbury went sombre (the knee-deep mud didn’t help). Even London’s Gay Pride march was downbeat – despite the salute from the Red Arrows.

Mr Cameron resigned even before most City types had reached their work stations. Mark Carney went on a live international newsfeed “to calm” the markets with a promise of £250 billion of additional liquidity. But the markets had already gone haywire.

As a “stop Boris” bandwagon started rolling within Tory ranks over the weekend, so the Labour Party imploded. Jeremy Corbyn faced the prospect of sitting alone on the Opposition front bench. Mr Cameron, a lame-duck Prime Minister, was presiding over a political class in disarray.

With no government to negotiate with, Mr Juncker, President of the European Commission ventured that the UK should be jostled towards la sortie in the shortest order. Frau Merkel demurred, saying that negotiations on Brexit should not be rushed and should not be “nasty”. The French started to mutter that the UK border controls at Calais should be removed.

Meanwhile, the Scottish question was re-articulated in shriller tones than ever. If the UK as a whole voted 51.9 percent to 48.1 percent in favour of LEAVE (a margin that even the über-Brexiteer Dan Hannan described as “slight”), Scotland voted 62 percent to 38 percent in favour of REMAIN. Over the post-ballot weekend Ms Sturgeon swept across the airwaves in a frenzy of busy-ness. The Scottish cabinet resolved to open negotiations directly with Brussels (something that Brussels wisely rebuffed); to consider holding a second referendum on independence; and then intriguingly unveiled an obscure House of Lords amendment to the Scotland Act requiring that any Westminster bill which enacted Brexit would be subject to the “consent” of the Scottish Parliament. Which Ms Sturgeon told us, in case we needed to know, would not be forthcoming.

Incidentally, it is questionable whether, constitutionally, Ms Sturgeon can trigger a second independence referendum without Westminster consent; and even more questionable that she would win it given that the economic case for independence advanced in 2014 has since been trashed. Though many Scots, so it seems, wish to be Greeks.

I will not explore here why the result was what it was. But I observe that the torrent of contempt from the European elites was deafening. Rather than take a moment to stand back and reflect on what has gone wrong in Europe – where a far-right candidate nearly became President of Austria last month – there was a rush to judgment. Bernard Henri-Lévy, the esteemed French philosopher, said it was the triumph of ignorance over knowledge.

May I remind readers where I stood throughout this process? I thought first out that the idea of referendum on Europe was a reckless gamble. I thought that Mr Cameron’ deal with Brussels in February, having promised a reformed Europe, was derisory. It confirmed our suspicions that Europe was un-reformable. I thought and wrote that Project Fear was contemptible – especially insofar as the impact on the City was concerned. (Apparently Lord (Mervyn) King agrees). I thought that the City types and the political establishment had severely underestimated the capacity of the great unwashed to turn around and bite them on the bottom. And I have consistently argued that the UK has alternative strategies for the future.

If the result had been REMAIN the Euro-train would have chugged on towards a thoroughly undemocratic and illiberal destination. That knowledge does not make me joyous about the result, however. We are in terra incognita. But I want to peer through the fog of uncertainty and to speculate on possible outcomes so that sensible investors can at least get their bearings.

We are faced with an extreme intersection between political and market risk stretching some way into the future. Britain has voted to leave the EU, but until such time as Brexit treaty comes into force (normally supposed to be two years away), the UK remains a fully functioning member of the EU. We are not likely even to invoke Article 50 until we have a new PM – perhaps longer. Further, we really don’t know what the precise terms of the Brexit treaty might be (though I shall hazard a few guesses). In fact we can’t actually be sure that Brexit will happen at all.

The referendum outcome has no force in British law. David Lammy MP has proposed that Parliament just ignore it – remember that out of 650 MPs only about 150 to maximum 200 are paid-up Brexiteers. And as I write (27 June) there are 3.6 million signatures on a petition that the referendum should be re-run. (If the number of signatories were to get to 17 million then that could be interesting. There is a lot of buyers’ remorse, or so it is said. Mind you, as I write there are more than 200,000 signatures supporting Londependence…) Or indeed it may yet turn out that the devolved assemblies have the right to veto a Brexit enacted by Westminster.

So where might we might go from here? The key issue for British business and finance is how to negotiate through four scenarios which I call, in order of their potential short-term negative market impact: Zero Brexit, Soft Brexit, Hard Brexit and Fuzzy Brexit.  Each of these has numerous variants of differing adversity.

Zero Brexit means that Brexit doesn’t actually happen; rather some form of words is devised that would entail a very high degree of continuity between the current dispensation and the next. This might come about by means of a reversal of the referendum (or if it is, for example, struck down by the Supreme Court). Tony Blair has already called in an article in the New York Times for a second referendum. Or it could entail a rearrangement of the furniture with mild concessions of a new deal from Brussels. For example, the British government could be offered the notional right to restrict benefits to new migrants (the so-called emergency brake).

This all sounds rather fluffy but the political risks of just consigning the referendum result to the dustbin of history might be dire. It would not be just Mr Farage & Co. who would kick up a stink. There could be a revolution.

Soft Brexit might entail a new status while retaining most of the institutional and structural links between the UK and the EU. The UK could be offered Associate Membership of the EU – a special status not available to others states. This would ensure freedom of movement but the UK would have the right to impose quotas on work permits issued to foreign nationals who would be assessed according to the much vaunted Australian style points system. The UK would pay to get access to the Single Market, like Norway. The British would largely escape the tyranny of the European Court of Justice.

The reason that I don’t think this is likely is that, if available to the UK, the Scandinavians and the Dutch would agitate for a similar status. Mind you, there may come a point where it is less painful for Brussels to concede that than to risk the implosion of the entire European project.

Hard Brexit would mean none of the above. The Brussels elite play hardball and the UK retaliates. The UK is locked out of the Single Market – meaning that of course we can trade but there will be tariff barriers on both sides. Freedom of movement in both directions might be restricted with holiday-makers requiring visas. Retired British citizens living in Spain would be charged for using the Spanish health system. (There are those who argue that this is effectively happening anyway and that “health tourism” is an issue for the UK which has not been addressed.) The UK would be free to conclude its own trade deals not least with the USA and the Commonwealth. It’s very unlikely that President Obama’s successor would block this.

Fuzzy Brexit is the notion that Europe might yet turn out to be Hotel California – you can check out, but you can never leave. Note that each EU member state will have a veto on the final Brexit package. It is quite possible that no unanimous agreement will be achieved. That means that there may never be a formal deal but rather that we have to make it up as we go along (something which the British are good at). We’d have to get used to radical uncertainty. Mind you, life was never certain anyway.

One of the reasons why the pound fell so sharply in the days after the referendum result was not so much the angst about the future of the UK economy but the fact that the foreign exchange market had called the outcome wrongly and had bid up Sterling to artificially high levels (it hit nearly $1.50 in New York on 23 June). When markets get things wrong the downside is amplified.

When the dust begins to settle the first recovery plays might be banks and airlines, which are already oversold. Lloyds Bank (LON:LLOY) is already looking cheap. Dealing in Barclays (LON:BARC) and RBS (LON:RBS) shares has been suspended as I write. This has been a drag on European bank shares – not least the Italians. They will recover – eventually. EasyJet (LON:EZJ) could easily bounce back when the markets realise that the Brits will never stop taking holidays – even if they are more expensive. In this space, the cruise sector could prove more attractive to higher end budget sensitive travellers. Check out All Leisure Group (LON:ALLG).

Safe haven assets include US Treasuries, though yields are pitiful, gold and specific currencies, especially the Yen. As I write the Pound is still under pressure but the Yen has become the currency port in the storm – exactly what the Bank of Japan did not want! Paradoxically, the Tokyo stock market is down more than virtually all of the European bourses. And London’s FTSE-250 index is down less than the DAX and the CAC-40. The downside in the European markets is probably as bad as in the UK.

The best trade has been and gone. That was to have shorted the Pound on 21 June – as I intimated in my piece that day.

And what about the new PM whom we now expect to take office by 02 September? Boris Johnson is the favourite – he was the life and soul of the Brexit campaign. But, in the numbers game, he didn’t seem to have done his homework. The problem with Boris is that he knows he is sufficiently intelligent to sail through most interrogations and to be confident that the exuberance of his own verbosity (as Disraeli put it) will be enough, without getting into boring old numbers. That doesn’t cut the mustard with the sort of people who read Master Investor.

It would be better if the Brexiteers had come out and said: It’s pointless discussing numbers because nobody remotely knows what they are… But from now on numbers are critical. I have read over the weekend that the UK, which has not negotiated a trade deal in its own name for more than 40 years, possesses no more than 12-20 senior civil servants with the skills and experience to send into the fray. We will need hundreds. Moreover, the entire ethos of the Foreign Office (and other governmental departments) is almost slavishly Europhile. Maybe this is a good moment for a bonfire of the vanities – to re-staff the top of the civil service with high calibre outsiders.

In the first instance, the new Prime Minister should appoint Michael Gove (who, whatever you think of him, has a genius level IQ) to head up a task force charged with the hugely complex business of negotiation. He should be supported by Gisela Stuart – a mother-tongue German speaker. He will most probably set out aiming for one of the four scenarios outlined above – probably Soft Brexit. We don’t know what the Johnson-Gove game plan is. And whether they get what they want is another matter.

Lord King has just said there is no need to panic. The economy was heading for a downturn anyway. I wish I could say that all will be clear in three months’ time but it will take much longer than that for the dust to settle. This is the end of the Western world as we knew it. But where there is risk, there is opportunity. And, as Boris and The Donald will tell you, there’s never an excuse for a bad hair day.