Politics, politics and politics but markets grind higher regardless

22 April 2016

This week the UK public were reminded that   a country’s economic outlook is significantly influenced by the quality of its trading relationships with its neighbours. The chancellor George Osborne presented some scenarios by the Treasury of how an exit from the European Union’s and its free trade zone may affect UK GDP and public finances over the medium to longer term. The analysis concluded that even under relatively benign assumptions the annual cost for every UK household of a Brexit could be over £4,000 per annum. However, if the UK  opted out of the right to free movement of EU passport holders – which appears to be what a majority of the ‘Leave’ campaign a striving for to limit all forms of immigration ‑ then the figure could be a multiple of the above. Brexit campaigners were quick to dismiss the figures either as outright wrong, because government paid economists had calculated them as a low price for true sovereignty. We beg to differ.  While it is true that none such calculations should ever be presented as hard facts – because they extrapolate expectations under assumptions into an uncertain future ‑ We have not come across a single, credible source questioning the notion that an exit would involve a cost to the UK economy nor that the treasury may have exaggerated the likely size. Indeed, the government analysis did not even include in their assumptions that an exit vote will cause considerable financial stress in capital markets (not just in the UK!) in the short term, with the potential to throw the UK back into recession for at least the next 18 months. Overall, the re-enforcement by the Treasury of what the Bank of England had already warned about some weeks ago appears to have had a sobering effect on public opinion about the likelihood of a ‘leave’ majority in the 23 June referendum. The entire affair is therefore now somewhat similar to what we saw in the run-up to the Scottish referendum, where passionate, patriotic arguments also appeared to win the day initially, until credible sources pointed out that such independence in today’s deeply interconnected world would come with a hefty price tag. We therefore agree with the reaction we have seen in the currency and bond markets, where £‑Sterling and government bond yields have recovered some of the ground lost in recent months over fears that a Brexit may have a higher probability than pure economic logic might suggest. We have seen politics beyond the UK also capture the majority of the public’s interest over the past week. As predicted at the Doha conference last week, oil producing nations failed to achieve any form of production freezes. However, those whom had bet on oil prices to rapidly fall back to the January lows quickly lost money on their positions. Declining production volumes of the US frackers and resurgent Global demand appear to have stabilised the oil price in the mid $40/bbl range, which should also mean that no further rounds of investment spending cuts in the oil exploration industry should be on the horizon, which should increasingly brighten the outlook for related industries. Politics in the US brought the right wing populist Donald Trump another step closer to nomination as US presidential candidate for the Republicans after winning the primaries in his home state of New York. This might indicate that he is able to muster a majority not only in the somewhat backwards Middle West and South but also the far more cosmopolitan and liberal coastal states. While this may be disconcerting from a European perspective, Hillary Clinton’s win of the Democrats nomination for NY proved that the middle and left of centre majority of the US electorate still prefers the less extreme choices. This broke left-populist’s Bernie Sanders’ winning streak of recent weeks and now makes it even more likely that Mrs. Clinton will become the Democrats presidential candidate. In my view such a constellation actually eases recent fears over US political instability. This is because Clinton is given the highest chances of winning the votes of the political middle spectrum of the US electorate which has historically always been the group that determined the winner of the US presidential elections. Political disagreement flared up in the Eurozone as well this past week, when the European Central Bank’s (ECB) president Mario Draghi used his monthly monetary policy press conference to remind German politician’s that while the ECB may be headquartered in Frankfurt its policy measures are for all Eurozone nations, not just Germany. This came after leading German government representatives including finance minister Wolfgang Schaeuble had blamed the central bank’s low interest rate policy for the rise of right wing political extremist parties in Germany. We noted that Schaeuble had stepped back from those comments in the interim. Perhaps this came after his economic advisers had reminded him that central banks’ interest rate levels are primarily set to achieve an equilibrium in money markets between price stability and supply of savings versus demand for credit. The source of Germany’s saving glut has most definitely more to do with a subdued economic growth outlook than the low level of interest rates. Economic growth stimulation, however, is the objective of political framework setting and if required fiscal stimulation. Monetary policy can aim to support and accommodate those aims, but can’t do the ‘heavy lifting’ of reversing macro-economic fundamentals. High time then, politics stepped up to the mark and refocused on the job at hand to lead towards economic growth instead of playing the populistic blame game. The rise of popular support for the political extremes around the world should have shown them that such tactics do little to secure re-election, but instead slow economic growth potential through the political uncertainty it introduces. It is therefore evidential that during periods of broad economic progress across all parts of Western society as we had it in the 90’s and part of the 00’s, public support drifted much more towards the political middle rather than the extremes on the left and right. Against the backdrop of so much politics it was pleasing to observe that capital markets were inclined to look beyond the shorter term and focused on the fact that after the January and February mini-cycle slowdown of the Global economy, growth has stabilised during March and April and the slow but steady economic progress has once again proven its resilience to short term disruptions. Unfortunately, as I mentioned last week, the already elevated stock market valuation levels, particularly in the US, increase the risk of another market wobble’ with every additional ‘up’ day. A consolidation of both market action and economic news flow is therefore what we will be looking for before taking investment portfolios beyond their current neutral position.