Market rally despite UK's central bank announcing emergency support measures for the economy
5 August 2016
The post Brexit Referendum summer of 2016 is panning out to be one of the most confusing periods for investors for quite a while. On the one hand, the UK electorate's decision to leave the EU casts long shadows over Britain's economic future and on the other, UK stocks are rising as if the UK's future prospects had just received a positive boost.
Over the past week this impression must have intensified after the UK's central bank (The Bank of England - BoE) announced, what can only be interpreted as emergency measures. An interest rate cut from the historic low of 0.5% to an even lower new historic low of 0.25% and a Â£70bn injection of additional monetary support to boost credit finance for UK industry and consumers.
So, who is right and who is wrong? The markets that are looking optimistically in the future, or the Bank of England, which even before the referendum, warned that a vote to leave the EU would have a significantly negative impact on the UK's economic prospects?
Well, we do not really know yet and while the markets are seemingly applying the benefit of the doubt that the future will be much less bleak than a full Brexit would suggest, the Bank of England has decided for erring on the side of caution.
Fact is that the post Referendum data flow for July has shown a very worrying, steep decline in the UK's economic activity levels compared to the previous months. But fact is also that the UK's government has postponed formal Brexit negotiations until 2017 and this allows time to develop less disruptive exit and economic affiliation models than perhaps assumed during the Referendum campaign.
We believe it to be deeply misguided to accuse the Bank of England to be pursuing a systematic campaign of scaremongering or talking down the economy, which essentially creates a self-fulfilling prophecy, just so their warning against a Brexit is proven to have been right. The BoE's obligation is to maintain a monetary framework and environment that allows the UK to prosper economically. Their actions of the past week have as a result been commended by commentators around the world as decisive steps to dampen the negative impact of the post Referendum activity decline as much as possible.
Unfortunately, with monetary conditions already at their utmost supportive levels, any further measures always suffer the effect of diminished returns. That is why there was also critique and doubt whether a further reduction in the cost of credit will have any meaningful positive effect, while surely further increasing the already existent negative side-effects like the unaffordability of housing for many. It was therefore equally commendable that the BoE's governor Mark Carney pointed to the limitations of policy actions by his institution against the potential size of the challenge and stating that 'The future potential of this economy and its implications for jobs, real wages and wealth are not the gifts of monetary policy makers'.
This was probably as unveiled as the BoE deems appropriate a hint to Westminster, that only politicians can address what politicians have caused: Structural uncertainty.
Returning to capital markets, it seems to me that their interpretation of the near term future of the UK is a more positive one than the initial reaction of the UK economy during July would suggest. Given two of the post Brexit vote worst case scenario elements did not materialise, namely immediate Article 50 notice to the EU and turmoil in Global financial markets, and furthermore the UK's political chaos was overcome quickly, July may well have been the worst it will get before the negotiations actually start.
As I have written here before, markets are sometimes willing to look further ahead and disregard short term deviation from the general direction of travel, as long as there is a reasonable expectation that contagion of a single country's ills can be prevented from spreading. The flow of recent economic data from the Global economy is supportive of such an assumption. Economic growth in the Eurozone has continued at a near identical pace and the US and Chinese economies show distinct signs of further acceleration.
That is good news for the near term future, because it should make it less disruptive for the UK to develop its new relationship model with the EU, when the rest of the world continues to operate in relative calm. At the same time, however, it also creates an inherently vulnerable environment, where the sentiment of capital markets and the business world can rapidly deteriorate if one of the previously stable variables suddenly declines.
This is the cause for the conundrum many investors face at the moment.
Intuitively, the current investment environment appears deeply suspect to them and they expect markets to suddenly crash at any moment. On the other hand, they see them rise further and further, week after week. For those who are already invested this is the usual level of discomfort due to uncertainty of short term variations to one's invested capital, which is also the reason why it earns a return premium over cash deposits over time.
For those, however, who currently have to make a decision over when to put their money into the markets, this environment poses and much larger dilemma. We have evidence for this from the numerous phone calls we have received over the past weeks, enquiring whether to invest now or wait until the '˜inevitable correction/crash' occurs.
We wish we could give a decisive answer!
What I do know is that the global economy and as a result international capital markets, currently have the potential to finally emerge from the slow growth environment of the past years. But because of the still fragile environment of low confidence in the future, versus present valuation levels which are usually only observed when sentiment is much higher, there is equally the potential for short sharp corrections as we experienced only at the beginning of the year.
My approach is therefore to refrain from trying to time the markets and instead build out one's investment position gradually over time. Private investors find it equally difficult to invest into falling markets as into rising markets - the fear is always to make a timing mistake. The better approach therefore tends to make the investment timing as coincidental but unemotional - just like the markets can be over the shorter term.
We call it '˜Pound Cost Averaging' - you may call it staggered investment over time. It is simply a time based investment plan, which spreads one's overall investment amount into a number of equal parts and then places these on a fixed time schedule in the market over a period of time. We have always fared best with 6 equal parts invested at the first trading day of the following 6 months, but if you want to diversify against the risk of mistiming even further and are less concerned about missing out on early returns, then split your investment into 12 and put a part every month.
The most important step is to get the investment started, because experience has shown us that timing the markets is near impossible even for the most experienced investors, let alone for the lay investor. Staggering the initial investment into a number of smaller parts should help overcome the natural mistiming fear that everybody has - usÂ included!