'Rancour to skyrocket' in Brexit negotiations: Kleinwort Hambros' CIO discusses.
'Finally, the prime minster Theresa May’s hand-delivered divorce letter to the European Union (EU) was filled with mature, forward-looking niceties. She promised to try to negotiate a ‘deep and special partnership’ with the EU, and said the UK would remain Europe’s ‘best friend and neighbour’. Awkwardly reciprocating the sentiment, EU Council president Donald Tusk said ‘We already miss you.’
However, few believe this is anything but pretence. There is glaring consensus that rancour will inevitably skyrocket, and there will be no winners. We tend to view any overwhelmingly one-sided market position as a contrarian opportunity.
First, the UK has a ‘goods deficit’ and ‘services surplus’ with the EU. Principal among these are financial services: the City provides 75% of foreign exchange trading and hedging products for the EU, and supports half of all lending.
The UK exports £26 billion of financial services to the EU, and imports just £3 billion. The UK has built an inimitable comparative advantage in these services; a sharp break in liquidity and capacity support could be detrimental to financial stability in the EU. On the other hand, the UK’s ‘goods deficit’ with the EU – including items such as cars and wine – is one where alternative suppliers are relatively easier to find. The UK is likely to have more leverage than many believe.
Second is regulation. The EU has labyrinthine rules applying to nearly every aspect of life. This extends from toasters to taxation. Furthermore, no meaningful and substantive legislation can take place until it has approval from all member states. The absurdity of this arrangement was highlighted last year when Belgium could not sign a key trade deal with Canada because of objections from its Wallonia region. Wallonia, an area of just 3.6 million people, held up an agreement approved by the EU’s 27 other governments, representing about 500 million people. Some believe that far from being a headwind, the UK will find it easier to trade with the rest of the world outside of the torturous strictures of EU process and consensus-building.
Third is an improving fiscal position. The UK’s net contribution to the EU is about £9 billion a year. This is substantial, representing about 0.5% of GDP. It adds up to £45 billion over five years. Put this number into context. The Hinkley Point nuclear power plant will cost about £18 billion; a new runway at Heathrow runs at about £18 billion. Both are game changing pieces of infrastructure for the UK, and the savings could pay for both in just five years.
The points set out in this piece are not predictions, nor are they political views. They are merely factors which are difficult to see in the cacophony resulting in the aftermath of the referendum. To many, this cacophony demands a call to action, stimulating a primal instinct to react. We will do no such thing.
During the negotiations – as markets digest and process new information – there may be elevated levels of noise for some time. Markets may move up or down sharply. They may settle, only to begin moving again. These events, in isolation, are not of concern to long-term investors. It is prudent to remember markets are replete with bouts of volatility.
The last seven years have seen many of these; ‘Taper Tantrum’, ‘Grexit’, the ‘Fiscal Cliff’, Brexit, the shock election of US president Donald Trump. In hindsight, each resulted in deeply oversold sentiment. Prudent investors eschewed the noise, remained focused on the fundamentals of valuation and momentum, and harvested the subsequent returns.'
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