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Brexit – What Next?

The financial world continues to digest the wide range of possible benefits, costs and implications of the ‘Brexit’ vote but the initial shock waves have calmed. Markets in the UK and Europe have recovered their post Brexit losses and the pound has started a tentative although erratic recovery. The implications of the British vote to leave the European Union (EU) will take some time to become apparent. The first step for the UK is to elect a leader to reunite the country and manage a sensible and practical negotiation with Europe.

We sent an email out to our clients earlier in the week summarising some of the key implications and the current views on the possible implications. In summary we made the following observations:

  • Though the UK is set for a period of significant political upheaval – a roller coaster that last night had Boris Johnson as the latest casualty: “Et tu Brute” you could hear him say as Michael Gove transformed himself from Boris’s campaign manager to rival candidate – but the leadership battle has just commenced and won’t be resolved until September, so there will be more political casualties along the way.
  • But this is not a credit or liquidity crisis. Central banks are well placed to meet liquidity needs if required. Indeed we’ve seen reasonably coordinated Central Bank action this year to smooth out patches of uncertainty. Economists now expect a 25bp rate cut from the Bank of England at their 14 July meeting; the Bank of England themselves predicting a ‘summer stimulus’. Economists have shifted their expected timing of the next US Federal Reserve rate hike to December, and the expected easing by the Bank of Japan could be brought forward as well, as part of a coordinated central bank move.
  • Unwinding British involvement in the EU will be extremely complicated, long-winded and distracting. The substantial political distractions and economic uncertainty will delay investment and raise prospects for a UK recession in the next couple of years, softened somewhat by the benefits of a weaker British Pound. Business confidence is likely to decline and this will make it harder for growth initiatives to get the green-light.
  • Putting this into perspective, the UK is less than 4% of world GDP with a contribution to global growth of around half that. Like many economies, Australia does not have significant direct trade linkages to the UK, though our economy will not be immune to spillovers from financial market volatility and broader uncertainty on business and consumer confidence.
  • Market influences have more recently been the prospect of the US interest rate rises, US dollar and oil price moves. These will remain key determinants of global prospects. Analysts near-term macro views for Australia remain unchanged with expectations of an RBA rate cut sometime before the end of the year, though there’s a higher chance the cash rate could be cut as low as 1% sooner.

Today, we wanted to consider one possible outcome that may have a positive impact on the Australian economy. In the context of global uncertainty and a relatively weaker global growth environment, it’s possible we’ll have less migration out of Australia due to the weaker relative growth prospects, and a pickup in arrivals into Australia as Australians (and others) return home seeking relatively better prospects. So any tendency for national ‘Brain Drain’ may become ‘Brain Enhancement’.

Indeed, the IMF’s April 2016 World Economic Outlook projected Australia’s economy will grow by ~18% (or 2.8% p.a.) from 2015 to 2021. That would make Australia the 11th fastest growing advanced economy, ahead of the USA, UK, Germany and Japan among others. However, it’s interesting to note that the IMF is predicting a slip in Australia’s ranking from 12th to 14th richest economy on a per capita basis which implies population growth is a driver. The IMF did predict overnight that Germany’s rate of growth would slow as a result of ‘Brexit’ uncertainty.

Population growth has provided a key support for Australia’s economic performance over years, outside of the mining sector. So, could there be a Brexit driven pickup in net migration inflows to Australia? If so, this would be a positive to the Australian economy – ironic, since this was one of the factors contributing to the leave vote in Britain.

A pick-up in population growth following the GFC supported housing prices and overall demand then. If this is repeated in conjunction with a reducing RBA cash rate, we might see our property prices continue to grow. What does this mean for negative gearing or capital gains tax concessions? With the Federal election tomorrow, perhaps this may trigger further debate for the new Government?

Overall, we maintain our view of a low growth global environment, with low interest rates to persist. In this environment, we’re focused on being well diversified, giving strong consideration to overall portfolio construction. Higher allocation to cash and deposits than normal provides the opportunity to add to equity positions if the uncertain environment offers opportunities.

A well-constructed, diversified portfolio should withstand the ups and downs of the current market. We seek to selectively invest in companies and funds that can continue to grow profits regardless (or perhaps despite) the low growth and volatile environment. We’re particularly looking for companies with quality balance sheets and reliable income streams. Ideally not too much debt – banks may start to increase lending restrictions as they become increasingly concerned about credit (i.e. the ability of borrowers to repay). This has again proven to be a prudent approach in the 2016 financial year and we look forward to a new financial year.

If you would like to discuss financial news and what it means for you, or just your investment options with one of our wealth management professionals, get in touch with Wotherspoon today!

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Disclaimer: All information in this article is intended to be general in nature for discussion purposes only. So you should not rely on it and seek personalised professional advice before making any decision.

One thought on “Brexit – What Next?

  1. Bill

    When asked to comment on the migration of New Zealanders to Australia, Prime Minister Robert “Piggy” Muldoon is reported to have said that it would improve the IQs of both counties. Just saying.

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