The FTSE-100 has been gliding around the stratospheric 7,500 level. So everything must be alright, then? Not necessarily. The FTSE-100 is powered by international market sentiment and the relative weakness of the Pound, which makes British blue chips look good value.
Now confidence is on the wane. The Institute of Directors issued a report last week suggesting that confidence by British business has crashed since the election. Just before, 34 percent of bosses were optimistic as against 37 percent who were pessimistic. Now it’s 20 percent optimistic and 57 percent “quite or very pessimistic”. And at the end of the first week of the Brexit talks the ultimate destination looks more uncertain than ever.
How worried should investors be?
From Mother Theresa to Cruella de Vil
Eleven months ago Mrs May came to power with a sense of hope and purpose: she was a strong, sensible, motherly woman who was going to do great things, not least for the Just-About-Managing classes who have been ignored for so long.
On 09 June Mrs May returned from the Palace to make a short speech outside Number Ten. It made no mention of the fact that her massive gamble had ignominiously failed and that she was now leading a minority government reliant on a bunch of Calvinists who believe that Creationism should be taught in schools.
Within 24 hours her anticipated cabinet reshuffle had come to naught – the big five ministers were all re-appointed – and her two precious advisors, Nick Timothy and Fiona Hill, were out of work. Mrs May was still in power – but a Head Girl under a cloud who knows that, one more mess-up, and the School Governors will not hesitate to expel her.
Then, out of the blue, came the Grenfell Tower inferno. Except that nothing comes out of the blue in life; everything has causes and consequences.
Take a bunch of Syrian refugees, Eritrean asylum seekers and assorted representatives of the most vulnerable groups in our society – and pack them into a tower block with no fire escapes, sprinklers or evacuation procedure. Clad the block with inflammable plastic. Then wait for a fridge to explode. Et voilà. Catastrophe.
We don’t even know how many souls perished in that blaze because many were living there unofficially…
This was a tragedy that we might have expected to occur in the squalid slums of Dacca or in the townships of Johannesburg. But to have happened in the richest borough of one of the richest cities on Earth was an outrage which has seriously tarnished Britain’s reputation as an advanced and civilised nation. How could this have been allowed to happen? And what do those council busybodies bearing clipboards and wearing Hi-Viz jackets actually do all day if they don’t assess fire risk?
(I’m not going to answer those questions here; but I will say that the problem is not a shortage of funding. Apparently, four top execs at the Kensington & Chelsea Tenant Management Organisation (KCTMO – of which Labour MP Emma Dent Coad was a board member) which managed the block, earned over £650,000 between them last year[i]. That would have been more than enough to pay for a sprinkler system).
Of course Mrs May was not responsible and cannot be blamed at any level for what happened; but she is the boss and bosses are called to account when things go badly awry. I am sure that, on a human level, she was deeply affected by the loss of life – but her ability to communicate that empathy was put to the test. A test that she failed.
All this – plus a new brand of DIY terrorism whereby any nutter with a grievance can justify mayhem these days – has plunged the UK into a black mood: one intensified by fear and uncertainty about where the nation is headed. On 21 June the veteran BBC journalist John Simpson tweeted that this is the worst year for Britain in my lifetime. And he was born in 1944!
Economic jitters
On Monday (19 June) the Wall Street Journal reported that The UK is fast becoming one of the global investors’ least favourite places to put money. It pointed out that UK retail sales are down, inflation is up to 2.9 percent and wage growth has slowed further. At the same time money has flowed out of UK funds for the eighth consecutive week, according to EPFR Global.
Consumer spending accounts for about 65 percent of the UK economy – as against an average of 55 percent in the EU as a whole; so a fall in consumer spending is likely to have a disproportionate impact here. Moreover, household debt is still rising while the savings ratio has fallen to 3.3 percent – the lowest level since official statistics started in 1963. In US Dollar terms the FTSE/JSE Local Index of UK-exposed shares has fallen by 14 percent since the Brexit referendum last year.
The Bank of England Monetary Policy Committee (MPC), when it convened on 15 June, kept interest rates on hold at 0.25 percent. But three out of eight members voted for an increase in rates. Yields on 10-year gilts firmed last week to 1.017 percent – still well below the peak of 1.5 percent last January. That suggests that institutional investors are moving into gilts in the expectation of a stock market fall.
Then, on Wednesday (21 June), Standard & Poor’s mooted that the UK may be due for a downgrade even before the Brexit negotiations are completed.
In contrast, in Europe the economic data is positive. Eurozone growth has outpaced the US this year at 2.3 percent in Q1 2017. Growth in Q2 is expected to be even higher. And Monsieur Macron is walking with a swagger. So the British team goes in to bat in sombre mood; while the European fielders bristle with confidence that they will catch them out.
The talks begin
The Brexit negotiations formally began in Brussels on Monday (19 June). If Mrs May couldn’t even negotiate a deal with the DUP, it is hard to imagine that it will be any easier with Monsieur Barnier & Co. A Dutch newspaper depicted the Prime Minister repeatedly hitting her own head with a hammer to the bemusement of her counterparts.
Elder statesman Lord Heseltine has a plan. The Brexit vote last year, he argues, was overwhelmingly driven by fears about immigration. If Mrs May (or her successor) could only get Frau Merkel and Monsieur Macron to concede restrictions on immigration, then Brexit could be junked. This blithely disregards the fact that Mr Cameron aspired to a deal on immigration and got virtually nowhere. (By the way, the UK population rose by 538,000 last year according to the ONS[ii], mostly due to immigration).
84 percent of the British electorate voted for parties which proposed to take Britain out of the European Union. The argument between Remain and Leave is over; the argument now is about what kind of Leave we work for.
Mrs May set out plans in January for a hard Brexit in which Britain would exit both the Single Market and the Customs Union, gain control of its borders and remove itself from the jurisdiction of the European Court of Justice (ECJ). The Labour position on all this is much more equivocal. It depends on the day. And it is now clear that Labour’s chief negotiating strategy is to oppose the Government, whatever the national interest.
But within the Conservative Party, which is traditionally close to business, there is an on-going struggle between those who believe that only a total break with the EU will fulfil the will of the people, and those who believe that all discontinuities should be minimised for the sake of trade. The disproportionately influential thirteen Scottish Tories are soft Brexiteers to a man and one woman.
So there is no automatic majority in the new Parliament for a hard Brexit; and there is probably a majority for a deal that avoids any frictions as goods cross the border between the UK and the EU. The only problem with this is that the soft Brexit option is no longer on the menu. Both Mr Davis and Monsieur Barnier affirmed on Monday that Britain would be leaving the Single Market and the Customs Union. Mr Davis said that Britain would then seek a free trade agreement and a customs agreement with the EU as a third party.
Such a free trade agreement, however, cannot even be discussed until the status of the 3.2 million EU citizens living in the UK, the Northern Irish border and the little matter of the Exit Bill are resolved. (It seems that Mr Davis has conceded that negotiations will be sequential rather than parallel.) That will not be before October, by which time a new German government – probably Merkel 4.0 – will be in the saddle.
Businesses for Soft Brexit
A report from the Kennedy School of Government co-authored by ex-Labour minister and ballroom dancer Ed Balls, found that almost all of the 50 leading British businesses they interviewed preferred that Britain remain in the EU Single Market and Customs Union.
On 20 June, Mike Hawes, Chief Executive of the Society of Motor Manufacturers used a keynote address to warn of the dangers that Brexit poses to the UK automotive sector. The UK automotive industry contributes £77.5 billion to UK GDP and supports 814,000 jobs. 80 percent of the 1.7 million cars manufactured in Britain each year are exported.
Mr Hawes reckons that a crash Brexit could cost the UK automotive industry £4.5 billion. Supply chains would be disrupted and the UK would be rendered uncompetitive overnight. A lot of senior British business leaders think the same. Jeremy Hicks, CEO of Jaguar Land Rover (owned by India’s Tata Motors (NSE:TATAMOTORS)) has said that its new range of models could be put at risk by failing to agree a good Brexit deal.
It is a similar story in the aerospace industry, in which the UK is the global number two. British aerospace companies export over £28 billion of product a year – much of that to the EU. Though, interestingly, under WTO rules exports of aerospace components are exempt from tariffs[iii].
It seems, however, that British industry is already taking steps to become less dependent on imported components. A report from the Automotive Industry Council showed that the share of UK-produced components in cars had risen to 44 percent this year from 36 percent last year.
The elusive free trade deal and the prospect of TRemain
So the trade negotiations will begin in late-October, most likely. (Perhaps on Saint Crispin’s Day, the anniversary of Agincourt). That will give negotiators just 520 days (including weekends and holidays) to conclude a deal covering every aspect of UK-EU trade and to get the sanction of the European Parliament before D-Day (29 March 2019).
Given that the negotiations will be conducted in four-weekly cycles, with one week per month given over to face-to-face negotiations, I calculate that leaves a total of not more than 69 negotiation days. Unless the Europeans generously offer Britain a presumption of continuity – i.e. they pretend to continue as if nothing has happened, which they have already said is impossible – we should assume that no deal is probable within the timeframe.
That begs the question of whether, instead of Britain crashing out of Europe on D-Day with no deal – which could be catastrophic for our exporters (and many of theirs) – there might not be a transitional arrangement whereby the UK remains effectively in the Single Market and the Customs Union, accepts the jurisdiction of the ECJ and continues to pay its membership dues for another x years (where x is an integer not less than two and not greater than ten).
The argument against a transitional arrangement is that it would take the pressure off the Europeans to reach a final settlement. The supporters of Remain would use the time available to try to force a re-think by means of a second referendum, or whatever. But, ultimately, the business community, assisted by a stalemate in Parliament, will champion business as usual – in fact, TRemain (temporarily remain). Or Limbo, if you prefer.
The ‘Elf ‘n Safety Brexit
The Queen’s Speech was delivered on Wednesday (21 June). Her Majesty was anxious to get away to Royal Ascot, so mercifully it lasted less than nine minutes. It had all the inspiration of an ill-punctuated mission statement of the Health & Safety Committee of an inner-city borough council: vacuous blandness alleviated only by pious virtue-signalling. The government would work for an effective and consensual Brexit…
It is very unlikely that there will be consensus over the final shape of Brexit, which Mrs May evidently desires. Rather, almost whatever the final outcome, there is going to be bitter recrimination for years to come. If Mr Cameron hoped to resolve once and for all the question of Britain’s relationship with Europe, in practice the outcome of the referendum has ensured that a deep wound is likely to fester for years more.
Just for the record, I still think that when Mr Cameron, after fouling up in Brussels, asked me the question: Do you wish to Remain or Leave? – there was only one answer I could honestly and honourably give. But I did so in the expectation that we would be taking huge risks, political and economic, that reversing 45 years of legislation would be nigh impossible and that things would not settle down for years.
What is clear is that the EU is moving towards some kind of federalist agenda where its members will be required to cede more and more sovereignty to Brussels. At some point or another, the British would have demanded out. So we just have to be stoical and get through this ordeal – even if Mr Carney is right, and that, in the short-term at least, we shall all be poorer.
To answer my opening question: investors should be very worried in these uncertain times. But if you think the UK will TRemain you might be more optimistic about the markets – if frustrated about the political process.
And there is another cause for concern quite apart from Brexit – and that is the prospect of a rapid and calamitous deterioration in the UK’s public finances. I will explain shortly why the chances of this happening have increased markedly since the election.
[i] Reported in The Times, 15 June 2017.
[ii] See: http://www.bbc.co.uk/news/uk-40372533
[iii] I will explore this in the July edition of the Master Investor magazine.