Unless you had trouble sleeping last night and were up watching TV, you would have awoke this morning to find that the UK voted to leave the EU and that Prime Minister Cameron had announced he would resign once a new PM is chosen. While the vote was expected to be close, no one can argue that the vote to “Leave” was a surprise. Markets across the world were discounting a “Remain” vote and, as such, the markets tonight and this morning are reacting in line with the uncertainty that the leave vote creates in the UK and the rest of the world. As noted in our recent piece on Brexit, a UK vote to depart the EU not only impacts the commercial enterprise of the UK and all of its trading partners, but also impacts the geographic borders of the UK and will ultimately cause a halt to immigration. The subsequent impact on the rest of the EU is in question. Also as noted in our Brexit note, the UK leaving the EU may cause other EU members to consider leaving as well, especially the stronger members that will be required to make up the UK’s share of “EU dues” that will no longer be forthcoming.
The UK’s vote to leave the European Union (EU) has clearly weakened the near-term outlook for the UK and global economies. However, we think that the issue will ultimately prove to be less damaging than many estimates have suggested. In the meantime, the market response to the outcome has been predictably negative, with the pound dropping overnight to a 30-year low of $1.34, which has subsequently stabilized at about $1.37. It is important to note that there were some analysts that had predicted a drop to $1.20, so the reaction has been less severe than some expected. The outcome clearly creates considerable short-term uncertainty which is likely to weigh on the UK economy in the coming quarters. Business confidence will presumably drop sharply and will likely be volatile as the situation unfolds over the next weeks and months. It will be imperative for UK leadership to stabilize the political and economic circumstance and quickly select a new governing party and leader.
The decline in the British Pound will serve the UK well as their goods and services will be more attractively priced. This will likely prevent the UK market from falling completely out of bed. While all of the European markets are down, the UK market is still above the February lows. It is important to remember that this referendum is not an act of law, but rather a vote expressing the wishes of the British people. However, the vote was so close that there will likely be demands for recounts, disputed interpretations, etc. Moreover, the UK will remain inside the EU for at least two years and possibly longer, all of which depends on negotiations between the UK and the EU leadership in Brussels. The protocol for an EU exit is very specific and it is likely that the EU will be very, very tough on the UK, if for no other reason than to discourage other members from initiating similar referenda. However, the EU project with a common currency, but disparate financial cultures, policies and controls among the sovereign members has been a very difficult puzzle to solve. This issue has become more acute in the post-financial crisis world and is trending in the wrong direction.
As expected, EU uncertainty has weakened the Euro and the safe haven currencies such as the Yen and USD have risen in value. The increase in the Yen creates further problems for Japan as the strengthening Yen makes their goods and services more expensive at a time when they can least afford a headwind to growth. This event will obviously cause the Yellen Fed to put off any rate hikes for the foreseeable future, regardless of any lip service they may pay. 10-year sovereign yields are down across the board with Japan at -20 bps, Germany at -5 bps, UK at 108 bps and the US 10-year at 1.57%. Our expectation is for yields to move lower as central banks will continue to believe they can “fix” the problem with more monetary easing. This event will also test the pricing and liquidity of the markets. The market’s initial reaction to Brexit has been a sharp drop down, but all things being equal, the down leg has been relatively orderly. While the US market is off sharply today, it remains nearly 12% above the February lows. It is important to note that the uncertainty of the Brexit vote prior to today has now been replaced by the uncertainty of how remaining EU members and the rest of the world will be impacted by this decision.
Globalization has done much to promote the top and bottom line of global companies, but one of the unintended consequences of globalization is the impact it has on the middle class of developed countries. Jobs and opportunities find their way to countries that offer the lowest cost employment, which in recent years as been in emerging countries like Mexico, China and Vietnam. As a result, middle class workers of developed countries have become increasingly less willing to live with the status quo. Developed country populations are expressing themselves with their voices and their votes, which is manifested in our own political climate. We suspect that this dynamic will continue.
The current economic and political landscape across the globe has been fragile and subject to surprise such as we saw last night in Britain. It is for this reason that we have been and remain cautious and defensive in our portfolio positioning. As always, we appreciate your confidence expressed in your continued partnership with us and welcome your questions, comments, and insights at anytime.
David E. Post
Chief Investment Officer
June 24, 2016
PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances. Investment decisions should always be made based on the client’s specific financial needs, goals and objectives, time horizon and risk tolerance. The statements contained herein are based solely upon the opinions of Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.
The 1976 film “Network” was written by Paddy Chayefsky, the renowned playwright, screenwriter, and novelist who won three academy awards, including Best Screenplay for Network. Network was directed by Sidney Lumet, whose films have regularly been nominated and won Academy Awards since his first nomination nearly 60 years ago. The all-star cast of Network included Faye Dunaway, William Holden, Robert Duvall and Peter Finch, who won the Academy Award for his performance as the film’s main character, newscaster Howard Beale. However, notwithstanding the critically acclaimed and award winning writing, directing, and acting associated with Network, the film will be most remembered for Beale’s on-air tirade in which he refers to the state of the economy, the price of oil, unemployment, the diminishing value of the dollar, and a runaway crime rate. Beale’s rant culminates in his urging anyone who can hear his voice to get mad and scream at the top of their voice “I’m mad as hell and I’m not going to take this anymore!!”
It is not a stretch to recognize the similarities between the global circumstances underlying the plot of Network and the circumstances in which we find ourselves today. We are now nearly eight years removed from the Great Recession, an economic circumstance that resulted from a generation of the world’s population living beyond its means through debt-fueled spending. To prevent the world from imploding in 2008, the world’s central banks employed a zero interest rate policy (ZIRP) hoping that no-cost money would spur economic growth by reviving the labor markets and increasing consumer spending. While eight years of ZIRP has allowed us to prolong the inevitable, it has not changed the fundamental problem of too much debt and too little global growth. Importantly, ZIRP and the even “better” (accent on sarcasm) negative interest rate policy (NIRP) have driven the prices of risk assets through the roof, much to the pleasure of those fortunate enough to own them. Unfortunately, owners of risk assets are a relatively small percentage of the population, so the circumstances of the average worker have not changed materially from the dark days of 2009 and for the average retiree the situation is far worse. Retirees and savers have essentially underwritten the largesse afforded owners of risk assets by central bank interest rate policy. Moreover, the average worker never really participated in the economic run up to the Great Recession and continues to struggle as labor hours and wage growth have woefully trailed most other economic metrics.
The chart to the right reflects the growth in hours worked since 1965, which includes almost non-existent growth in hours worked since 2000. From 1980 to 1990 total labor hours grew by 23.5%, but for the 15-year period ending December 2015 total labor hours grew by just 2.3%. This woeful growth rate in hours worked wasn’t due to a lack of labor supply. In fact, in 2000 the civilian population of the US aged 16 to 65 was 177 million, while today the number stands at 205 million. The disconnect here is that the labor pool has grown by 16% since 2000, a rate 7X faster than the number of hours employed. In addition, the vast majority of the recent improvement in job creation has been low-wage work, not head-of-household jobs. And, while wage growth has begun to increase over the past few months, vast government wage data suggests that real wages, that is nominal wages adjusted for inflation, have been flat or even falling for decades.
These job and wage metrics are similar for many developed countries and these facts and conditions are the seeds for discontent. Howard Beale’s rage in Network was his expression of discontent. However, the discontent of the average worker and retiree, as well as those who are tired of political polarization and a dearth of legislative accomplishment by Congress, as well as those in the world who fear geopolitical unknowns, have all chosen to express their dissatisfaction in the form of anti-establishment support. This collective disgruntlement is being expressed in the support of Donald Trump, Bernie Sanders, Brexit, and all the other anti-establishment movements across the globe. People are tired of the status quo and want something different, even if it isn’t well thought out. To wit, Bernie Sanders has been accused of promising such things as free college educations, health care, family leave, etc. At the same time, Donald Trump argues for lower taxes and says “don’t worry about the national debt. We can always print more money!” Donald and Bernie are both asking for free “stuff” today that will presumably be repaid at some date in the future. This has been standard operating procedure for the past 30 years, so it seems less than well thought out that an anti-establishment vote would result in the status quo!
On June 23rd a referendum is being held in the UK to decide whether Britain should “remain” in or “leave” the European Union, commonly referred to as Brexit. Similar to the anti-establishment groundswell of support for Bernie and Trump, the Brexit vote is essentially another instance of challenging the status quo. In addition, similar to Bernie and Trump, a “leave” vote by Britain was once considered a long shot and today has a much higher probability of passing than anyone originally thought possible. In fact, over the past several weeks the Leave vote has gained momentum in the polls and is now given a slight lead. However, the historically more accurate wagering markets still show an advantage to Remain.
There are many issues that weigh on the Brexit vote, but the single largest issue at debate is the economic impact on the UK. As is always the case, in the heat of battle both sides paint a calamitous picture of the economy should their side lose as well as an overly positive economic impact if their side wins. We do know that leaving the 28-nation EU would require an untangling of complex trade and other deals that tie Britain to the European bloc, agreements that have been negotiated since the initial formation of the EU shortly after World War II. It is estimated that this detangling process could take as much as five years during which time business dealings would become more complex, but would likely not meaningfully impact GDP growth over the long term. However, given today’s relatively fragile economy in the UK, there is increased concern that over the short-run Brexit may trigger a recession.
While most have focused on the impact of Brexit on Britain, there is increasing anxiety among EU members that a vote for Brexit would exacerbate an already tenuous relationship between EU members. In fact, a UK vote to leave the EU would lower the barrier of exit and may embolden other EU members to consider doing the same. A basic financial dynamic is that in 2015 the UK contributed 12.5% of the EU budget, which amounted to about £13 billion, an amount that would have to be covered by the remaining EU members. Germany already bristles at having to “carry” more than their EU weight and an additional burden could cause Germany to stand up and yell “I’m mad as hell and I’m not going to take this anymore!!” Given the stakes at hand, we expect the Remain vote to prevail. However, after witnessing the unpredictable success of Trump and Bernie, one shouldn’t underestimate the power of anti-establishment sentiment and the willingness to challenge the status quo.
Given the uncertainties in the global political and economic landscape we remain defensive in our portfolio positioning. As always, we appreciate your confidence expressed in your continued partnership with us and welcome your questions, comments, and insights at anytime.
David E. Post
Chief Investment Officer
June 14, 2016
PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. This market commentary is a matter of opinion and is for informational purposes only. It is not intended as investment advice and does not address or account for individual investor circumstances. Investment decisions should always be made based on the client’s specific financial needs, goals and objectives, time horizon and risk tolerance. The statements contained herein are based solely upon the opinions o
Telemus Capital, LLC. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice. Information was obtained from third party sources, which we believe to be reliable, but not guaranteed.