The process of leaving the European Union has descended into a farcical war of attrition. John Stepek looks at what it all means for your money – whatever the eventual outcome.
Whichever side of the Brexit debate you’re on, it’s been yet another week of confusing and depressing headlines. With the 31 October deadline looming, Prime Minister Boris Johnson was meant to be having a summit with the European Union (EU) at the end of next week. The hope was that we’d have some sort of deal agreed by then, which would avoid Johnson having to ask for an extension – or to challenge the legality of the Benn act, which could force him to do so. But at the time of writing the state of talks means it looks as though he might not even turn up. How did we get to this stage and, more importantly, what does it mean for your money?
Setting constitutional confusions aside, ultimately Brexit has stalled for one simple reason: the parliamentary arithmetic is against it. Johnson’s predecessor, Theresa May, managed to hamstring herself with her catastrophic 2017 election campaign. This left her without a majority, which in turn led to a situation where no deal – let alone one deemed acceptable by the EU – could get through Parliament. Meanwhile, it raised the hopes of all of those on both sides who would prefer Britain to “rethink and remain”, removing any incentive on the EU side to compromise. As a result of all this, we now have one major party in the UK – the Liberal Democrats under Jo Swinson – which is actively campaigning on a platform of ignoring the referendum result altogether; an opposition party that is trying to be all things to all voters by calling for a second referendum, the result of which it may or may not support; and a party of government that has had to expel 21 of its own MPs, leaving it with no majority in the House of Commons.
As Helen Thomas of Blonde Money points out, all of this really leaves Johnson with just two choices. Either he attempts to barrel out of the EU on 31 October, hoping that some combination of momentum and legal obfuscation can carry him over the finish line; or he treats this as one long election campaign, positioning himself and the Conservative Party to recapture disillusioned voters from Nigel Farage’s Brexit Party, as and when Parliament decides that it will allow a fresh general election to take place.
What this means for your money
Given where we are, what do investors need to prepare their portfolios for? It’s not easy, but it’s worth trying to consider scenarios that might have lasting impacts on your wealth. There are two dimensions to consider here. On the one hand you’ve got the Brexit outcome: will we leave, or will we remain (like it or not, the possibility of the latter needs to be considered). On the other, you’ve got the threat of a Labour government led by Jeremy Corbyn (again, like it or not, this would be a major change to the investment environment, the likes of which most under-50s have never seen).
On Brexit, there are three potential outcomes: “no deal”, “some sort of deal” and “remain”. No deal is presented as the scary option and in the short term it probably would be. But one way or another, once we leave it rapidly has to morph into being very similar to the “some sort of deal” scenario – Britain and the EU will have to settle down to talks about the longer-term shape of the relationship. The main difference is that with no deal there’s likely to be a short, sharp drop in sterling, whereas a deal would see a rally.
What about if we remain? Clearly there would be quite a bit of back and forth before we got to that point – there would need to be a general election, then perhaps a second referendum and then no doubt more discussions with the EU. That’s not to mention all the political anger. But you’d expect the pound to rebound quite strongly on the prospect (although in the longer run, as we note on the left, sterling’s days could well be numbered under that scenario).
In all, if you believe that UK stocks are cheap now – and with the FTSE 100 overall offering a dividend yield of about 4%, they are – then the prospect of Brexit alone shouldn’t put you off topping up your portfolio. Don’t touch open-ended commercial property funds (we’ve always said it’s a bad idea to invest in illiquid assets via a fund structure that promises daily liquidity and it would be an especially bad idea in a no-deal Brexit). But you could opt for a simple tracker fund or exchange-traded fund to track the market passively (see page 16). Or if you want to delve into stock picking, then as Tom Howard notes in The Times, Swiss bank UBS this week highlighted – among others – British Airways owner IAG (LSE: IAG), advertising group WPP (LSE: WPP) and Barclays (LSE: BARC) bank as looking cheap.
What about a Corbyn government? Opinion polls suggest this is a low probability outcome, but we’ve heard that before. The wealthier you are, the more preparation you need to do. But at a basic level, make sure you’ve used up your Individual Savings Account allowance (even Corbyn would think twice about scrapping Britain’s most popular tax break). If you are a residential property landlord, you absolutely must have an exit strategy in place – we can’t emphasise that enough.
And something that will help in any scenario is to diversify. All investors suffer from “home bias” – we keep too much money in assets denominated in our home currencies, relative to their global importance. For example, the UK stockmarket accounts for less than 5% of global market capitalisation, while the US is on around 40%. Yet most British investors have a lot more money in the UK than in the US. There’s nothing wrong with this if it’s a conscious choice – indeed, we’d argue that US stocks are expensive and so you probably should be “underweight” the US. But while we feel the UK is cheap, don’t neglect the rest of the world. The ever-optimistic Anatole Kaletsky of Gavekal Research reckons now could be a good time to invest in continental European stocks – “the present slump… in the euro and in European cyclical assets is likely to prove a buying opportunity and not a sign of Europe’s terminal decline”. Montanaro European Smaller Companies (LSE: MTE) has the best five-year track record of any investment trust in the sector, and trades on a discount of 6% (disclosure: MoneyWeek editor-in-chief Merryn Somerset Webb is a non-executive director on the trust). Another option with a solid record is JP Morgan European Smaller Companies (LSE: JESC) on a discount of 15%.
Why “remain” cannot mean “business as usual”
While we’ve been debating Brexit the rest of the EU has not stood still. Specifically, thanks to outgoing European Central Bank (ECB) boss Mario Draghi, quiet but significant progress has been made towards further integration. The eurozone’s big problem has always been that its members are ill-suited to sharing a currency. For example, interest rates will generally be too high for Greece and too low for Germany.
To offset that requires closer fiscal integration (ie, fiscal transfers between strong and weak economies), which also means closer political integration (if voters are to accept such transfers, one member can’t offer much better welfare benefits than the rest).
As the Greek sovereign-debt crisis made clear, the risk was always that these internal contradictions would blow the eurozone apart, due to the risk that an individual member – crushed by the overly strong currency – would be forced to default on its debt. But during his time at the ECB, Draghi has focused on overcoming Germany’s objections to printing money to buy sovereign debt (quantitative easing – QE).
Now, thanks to Draghi, the ECB is effectively like the Bank of England or the Federal Reserve – a central bank with the ability to print money at will to avoid technical default or a banking system collapse. So while we haven’t seen a lot more political convergence, the risk of a single country going bust is all but gone.
Sure, it’s not that simple. The ECB doesn’t exactly have carte blanche on this, which is why it still costs Italy a bit more to borrow than Germany. But Draghi has made it politically far harder for the Germans (and the “saver” nations as a whole) to resist QE, because if a crisis blows up in future and the ECB is prevented from acting, then the blame lands on them. As Brexit has shown, no nation wants to be seen as the unreasonable one.
By extension, it now seems logical to believe that the euro will not collapse unless a member state actively votes to leave. That’s possible in the longer run – indeed, my colleague Merryn Somerset Webb pointed out years ago that an exit driven by frustrated German savers voting to leave may be the most likely endgame for the euro. But that’s a slow-burning problem. Even eurosceptic parties within the eurozone realise that campaigning to leave the euro itself is a vote-loser. Very few people are willing to risk seeing their banking system shut down and their savings devalued by 20%-50% overnight (depending on the country) when they revert to their previous currency regimes.
With eurozone nations effectively locked into the euro, further integration is a matter of time. That’s why Christine Lagarde – a French politician and former head of the International Monetary Fund – is taking over the ECB. Draghi delivered the monetary safety net – now it’s her job to weld member states together politically. It’s also why Germany’s Ursula von der Leyen – who, as the Financial Times notes, has said she believes in the “United States of Europe” – is now becoming European Commission president.
So in the UK we need to be more aware than ever: “remain” does not mean the “status quo”. Instead, it puts us on a long-term pathway where, having seen the apparent futility of exiting the EU, we end up joining the euro.