Legg Mason: The EU referendum and subsequent market events
Legg Mason Global Asset Management and its affiliates have given their views on the Brexit decision, including what the impact has been on investment markets, what the vote means for UK interest rates, whether some segments of UK stock markets (such as banks and housebuilders) are now oversold, and what it means for government bond markets.
In the Q&A below, a number of spokespeople from the business get to grips with the implications of the recent vote.
The political implications of Brexit:
Andrew Belshaw (AB), head of investments, London, at Legg Mason affiliate Western Asset, said: Only a fool would invoke Article 50. You cannot have a referendum at the end of it so it’s a take it or leave it decision. There’s no recourse to the electorate, with the whole process controlled by the EU. That’s why I think Article 50 should not be invoked. In fact, the longer it isn’t, the better – because under the EU constitution they cannot force us out.
Michael Browne (MB) portfolio manager at Legg Mason affiliate Martin Currie, and co-manager of the Legg Mason Martin Currie European Absolute Alpha fund, said: It’s in the interests of the French and Germans not to invoke Article 50. They have huge elections coming up in May and September next year, and the one place you want the UK going into those elections is on the naughty step. You want them firmly in everybody’s bad books because it plays beautifully to your domestic policies. So I don’t see any chance of it coming up between those two elections.
MB: The volatility will last years.
AB: I agree. I’ve always thought that post a leave vote it would be a five to ten year exit.
The recent falls for banks and housebuilders:
MB: The house builders are discounting a 10% fall in price for a short period of time. That has significant secondary wealth effects and puts a large number of recent borrowers into negative equity. That brings us back to the banks. Interest rates cuts and negative rates are extremely dangerous and very negative for their overall balance sheet profitability and their ability to continue to lend. That will have an impact on their behaviour.
This leaves you with an economy that’s been built on services for the last few years with heavy employment of the over-50s. This mix means there’s going to be something of a recession in the UK. It won’t impact Europe much. A weaker euro will be beneficial. But Europe will be the plaything of the economic world because all the bullets in terms of QE will have been shot.
So the outlook for UK equity markets is significantly worse than Europe. But Europe could see opportunities as its currency weakens.
UK interest rates, quantitative easing, and the likelihood of recession
AB: It (the base rate) goes to zero for me and QE depends on how the capital account reacts.
MB: The impact of the Leave vote is already clear. We had a huge profit warning from one mid-cap company this morning, making the point that their business had fallen off a cliff in early May and continues to decelerate. I would expect business investment to have already turned sharply negative and continue to do so in Q3 and Q4. Clearly, the consumer is over-borrowed and there will be a reaction on that side, particularly in the wealthier areas that voted Remain.
Therefore you have to anticipate a quicker, sharper slowdown in the UK economy. We are taking our numbers down for next year to 0%, which implies that GDP must be negative in the first couple of quarters. And I would not be surprised to see a similar figure for this year because of the reaction from business and consumers.
Where we go in 2018 is a really interesting question. It starts to ask questions about certain parts of the economy. There will be negative rates if there’s that degree of QE. Banks will face significant cuts to their margins and therefore will they be able to lend? Will they be forced to raise capital again either through retained profits or the markets? You then start to ask questions about the prospects for house builders and other areas of the economy. It could all lead to a prolonged period of economic gloom or recession. And that might be exactly what our colleagues in Europe want to force us back to the table in 2018 with our tail between our legs.