Tuesday, June 14, 2016

Brexit - "Stop the world... we want to get off?"

We've been reading a lot over the last week or so on the UK's EU referendum and the recent reaction to tightening opinion polls. What follows is a precis of the various views we think sound logical:

Opinion polls have narrowed sharply, with a number giving a growing lead to the “Leave” camp, but bookmakers still imply that the probability of staying is around 64% - lower than it was a month ago, but still well above what opinion polls imply, and of course still well above 50%. It is clear however that the gap is narrowing quickly. 

The pro ‘Brexit’ surge is not so much about the UK’s membership of the EU, but also about an expression of general angst against the economic elites, unchecked immigration and globalisation. From a purely political perspective, the focus by the ‘exit’ side on the issue of immigration has been a shrewd one. 

Why? The UK electorate was never truly consulted on the decision to permit large scale immigration … this was fine when jobs were plentiful and real wages were rising but in the post-crisis world, neither can be taken for granted.

Moreover, there is the anti-establishment vote, which has grown tired of political correctness (also a big factor behind the rise of Donald Trump in the US). The constant emphasis of the “Remain” side on the negative economic uncertainties has failed to tabulate a more positive case in favour of staying, and, inevitably, British bolshiness is kicking back against such a negative message.

However, we still believe that the ‘’Remain” camp will ultimately prevail (although uncertainty is likely to dominate events between now and the 23rd June) because of:

1. Telephone polls: These were much more accurate in predicting the 2015 UK general election result … and they show a lead for the ‘Bremain’ camp (54% versus 38%). The most recent ‘Brexit’-leaning polls were all conducted online and therefore could prove a lot less accurate. 

2. The ‘Undecided’: These continue to average ~10% of the electorate in the major polls, a significant figure. We can never be entirely sure of this, but we expect such undecided voters to go with the status quo - similar to what happened in Scotland, where the ‘No’ camp enjoyed a surge in support days ahead of its independence referendum (in fact, the ‘Yes’ camp enjoyed new support as well, but not enough as it turned out). 

3. The Undecided in the ruling Conservative Party: Some view this as their ‘marginal voter’ and those in the party who need to break in favour of ‘Bremain’ is a lot less than it was in March. 

So it still looks as though ‘Bremain’ will ultimately win 50% to 55% of the vote. If the UK – the country with the lowest economic, geopolitical and cultural threshold among EU countries for going it alone – chooses to remain in the EU then it will reaffirm the continuity of the European Union, whilst countering those who think it will fall apart.

But… if that’s all wrong, and the vote is in favour of leaving the EU, what is priced in currently? 

Anecdotal feedback from institutional investors point to markets being long on fear and short on conviction: many are simply sitting on their hands right now. Therefore, either referendum outcome could unleash sizable investor activity: a “Remain” vote would be positive risk assets and a “Leave” would be negative.

For global markets, the S&P500 index close to its record highs, very little ‘Brexit’ fear appears to be priced in - nonetheless, despite the near-record levels on the S&P500 index, investor sentiment is already pretty cautious. This might help to limit downside I the event of a “leave” result, and if not, then a sell-off would be a good buying opportunity. 

The short term outlook for UK and EU equities in the event of a “Leave” vote could be potential falls of -15% for both. Both the GBP and the EUR would also be likely to fall: current forecasts are that the USD-GBP rate could fall to $1.30 on a worst case scenario basis versus $1.41 today). 

However, any weakness in sterling will be offset by a rise in the sterling value of overseas earnings for any externally focused businesses and it’s worth pointing out ~72% of the FTSE100 index company revenues are derived from outside the country. It’s a much less compelling story for smaller businesses and/or ones that are more domestically focused, since domestic demand seems likely to slump in the short-term as companies of all sizes work out what to do (we don’t get the sense that many firms have been developing contingency plans for a “leave” vote). The chances of any business making big investment decisions in that type of opaque environment are virtually nil. 

For EU equities, beyond the initial knee jerk sell-off, valuations seem attractive against an overly bearish background. One bank we talk to is projecting a Euro Stoxx 600 index target of ~390 over the next 12 months, or around +14% up from here, regardless of the referendum result.

The immediate concerns many markets will have is whether or not a UK vote to “Leave” will flag eventual EU disintegration (and with it the Euro). This view will be put into stark relief by movements in the Euro, and in Italian and Spanish sovereign bond prices from next Friday onwards. 

However, such concerns will likely fail to appreciate that the rest of the EU’s member states have higher thresholds for going it alone (i.e. they have greater economic and geopolitical constraints to exiting). Our take here is that the relevance of the referendum is much greater for the UK than it is for the Euro area as a whole.

Maybe, once the perpetually grumpy Brits have quit the field in a huff, the rest of the team can get on with the task at hand with fewer distractions. 

e-mail: steve.davies@javelinwealth.com
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Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Tuesday, May 31, 2016

Is it all about TINA?

A new acronym has been touted about recently with regards to why stockmarkets remain attractive: in the contest to find the least unattractive investment asset at a  time of slow earnings growth and high valuations, TINA wins, or "There Is No Alternative".

Why is this so?

It is certainly the case that - as we've been saying for a while now - equities look the least unattractive of most asset classes, if only because the other asset classes look even less compelling.

Fixed income - at least short-term - will remain vulnerable to rising interest rates, and with yields continuing to hover around generational, multi-decade historic lows, the only way for yields to move, in a (gradually) rising US rate environment, is up (so bond prices come down). From an income perspective, when compared with equities on which the global yield is in the region of 2.5% plus, the income attractions of equities seem more compelling too.

For other asset classes, such as commodities, it remains the case that it's all about China, and since we're wary on China, so we should be wary on commodity prices (even if these look to have stabilized above the lows they established back in February). For hedge funds, whilst these do have a place in most portfolios, the performance of many of these in the last few years have been distinctly below average; with one or two exceptions (and these are the ones we like), they make more money for their managers than they do for investors.

So - whilst equities seem to have been the default asset class for a while now, that position seems unlikely to change any time soon, even if they still exhibit periodic bouts of jaw-dropping volatility, as we saw in January and early February of this year. The end result is that the tide of money eventually comes sloshing back and prices get back to where they once were.

Although this seems relatively sanguine, we continue to think that this makes sense notwithstanding occasional nervousness.

Having said all that, the outlook for various markets is more nuanced... top of the attractiveness league table come special situations such as Vietnam and India. The former is benefiting from steady growth, a stable currency and gradual reform, the latter is benefiting from much the same as the Modi government starts to recover its mojo and begins to deliver on some of those sky high expectations of a few years ago.

Whilst Europe remains a sluggish growth area, the offset is that ECB policy will remain highly accomodative and that means the prospects for valuations and earnings growth are reasonably solid. The US, however, looks less good value than most, if only because earnings growth seems to have peaked and valuations as a consequence are already looking full.

We also look at more thematic stories: investing in companies that buy back their own shares (on the basis that such buybacks boost the share price by limiting supply), or by looking at structural themes such as US housing. Who knows, at some stage, even the much unloved banking sector could look appealing.

Getting into the second half of the year, the uncertainties of the US election will continue to keep us variously entertained, or scared witless (if the anti-trade rhetoric of both sides ratchets up).

Whilst we can only hope that the realities and restraints of office will force greater pragmatism in office, a core them from both Democrats and Republicans would seem to focus on infrastructure spending which could imply a mini-stimulus package being pushed through in the early months of 2017.

For markets, that should be a favourable undercurrent, and any politically inspired weakness ahead of the election could be used as an opportunity to put cash to work.

contact: +65 65577186
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Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.