I have been meaning to crack on with this Blog for weeks but various distractions have conspired to stop me getting it done. It is a bit of a contentious subject as the Politics around it are beyond extreme but I just want to put into electrons how I see things playing out and how I will be managing around the Brexit Negotiation developments to ensure my Portfolio is protected. I have had a lot of painful discussions about this on Twitter but the upside for me is that they enable me to think through the Scenarios and to come up with a Roadmap of Options which will help me frame my approach.
In essence and at a High Level (there is no point in thinking lower than this - everything is unknown at the moment and most of the stuff anybody says or writes about this subject is useless speculation and 99% of the time it has a Political Agenda behind it on one side of the ‘debate‘ or the other) I think there are 4 possible Outcomes of the Article 50 Negotiation Process which we need to consider:
1. UK leaves European Union with a full Free Trade Agreement and easy access to the Customs Union - this is pretty unlikely but it is a possibility and would be absolutely the best possible scenario. Note, I don’t see any ‘Divorce Payment’ being an issue - even if the UK pays it there will be some political noise for a small period of time but then it will all blow over. To the Markets it will mean nothing but overall they would love this Deal - although there is a risk that the Pound might rise and this could bizarrely hit the FTSE100 etc.
2. UK leaves EU with a Deal that is not as good as Scenario 1 but is better than a Trading Relationship based on WTO Rules (World Trade Organisation) - Perhaps this is actually the most likely but it is difficult to articulate what it means in detail. At a guess (now I am speculating !!) it might mean Free Trade with the EU (no Tariffs in other words) but perhaps the Customs Union might not be as easy to deal with and there might be difficulties with certain Sectors like Banking. Anyway, that is besides the point, the key is that it is not the Optimum Agreement but it is better than the utterly inferior WTO based Relationship. In this scenario, I think the Markets would be entirely happy and the critical element here that people just do not seem to get their heads around, is that as long as the Process is slow and steady, then Businesses and the Economy will have time to slowly adapt - this is such an important point, Economies and Markets hate shocks and with plenty of time the problems will be figured out and Business in aggregate will adapt. At a Sector level there will be Winners and Losers but that is irrelevant - for our purposes with regards to our Portfolios, the key is that things will be steady and controlled.
3. UK leaves EU on good terms but the Trading Relationship is based on WTO Rules - this is a very inferior Outcome but as with Scenario 2, as long as it is slow and measured and with ‘Transition Arrangements’ then I do not expect it to cause much if any upset in the Markets. Yes, there will be Winners and Losers amongst Sectors but overall things will keep plodding along. This is the scenario where the Pound will stay low but this will help Exporters offset the impact of Tariffs and suchlike. Again businesses and the Economy will adapt. An important element here will be from both the UK and the EU Authorities clearly and calmly communicating to the Markets and the Public what is going on - any Shocks could cause trouble.
4. UK leaves EU by crashing out of the A50 Talks and has no Trading Agreement sorted - The key here is ‘crashing out’ - this would be a shock to the Markets and to the Global Economy and I call this “Lehmans2” - I think it would be utterly catastrophic and cause a severe recession. This is the only Scenario we need to worry about I think and our efforts should be put into monitoring how the Talks are going and being ready to move fast if we get a sniff that the A50 Talks are about to break down in an ugly way. In this scenario it would cause utter panic in Businesses and for Consumers (‘Network Effects’ would come into play here where the fear amongst consumers spreads like wild fire - this is what happened in 2008 when people spoke to their friends and neighbours etc. and everybody was worried and spending was quickly reined in as Consumer Confidence evaporated overnight) and it would be a ‘Heart Attack’ moment for Stockmarkets and for the Pound (conversely we might see the Pound tank and the FTSE100 rise but it is very possible that everything falls because the Fear would spread instantly and people just want the safety of Cash). In addition, it might be even possible that UK Government Bonds (Gilts) fall and therefore Yields go higher - this would be because Overseas Investors would flee UK Assets and the usual ‘Safe Haven’ standing of the US (particularly Treasury Bills) would suck in the funds. Eurozone Bonds could also be under pressure. This latter bit is irrelevant really because the key point here is around the Shock and sudden nature of the Talks collapsing, but the UK would leave the EU probably with no Divorce Bill being paid (meaning the UK becomes the subject of various Court Cases etc.) and no Trading Agreements of any sort arranged - in theory WTO Rules would apply but in practice I suspect this would be a total mess. Forget all the BS from the usual suspects - this really would be ‘Hard Brexit’.
There is so much nonsense being talked on both sides of the Brexit political debate - as with all things we Investors/Traders need to cut through the noise and tune out our own Political Biases and recognise the extremes of thinking on both sides and stay calm, rational and analytical. I cannot stress this “extremes” point enough - the Brexiteers are dreaming of a future for the UK that is paved with gold and has Robbie Williams clones for all the girls and Angie Jolie clones for the boys - of course this is all exaggeration (think Harry Enfield and ‘The Slobs‘). On the other side, the Remainers see doom and gloom and the end of civilisation - this is equally nonsensical. Apart from Scenario 4 of the Shock Collapse of the Talks, I suspect all of these possible Outcomes will involve some sort of ‘Transition Period’ of probably several years after the UK officially leaves the EU - this is all good stuff because as I have mentioned, a slow orderly process is essential to avoid trouble.
As I have outlined above, I see only one Scenario that fills me with dread but I think this has the potential to be utterly catastrophic and I call it “Lehmans 2” because I really think it could be that bad. I have seen people saying that if such a Scenario took place the UK would be doomed but the EU would be fine - this is highly unlikely simply because the UK is the 5th or 6th largest Economy in the World and a major Customer of the European Union - if the UK goes down in a ball of flames, then it will take all Western Economies with it. And this is without even considering the importance of the City of London to the Global Banking System. On top of this we can also throw on the fragility of the Eurozone Banks - whereas the US and UK have taken big strides in re-capitalising their domestic Banks, this has not been the case in Europe where even once imperious Institutions like Deutsche Bank are clearly rather wobbly - and the Italian Banking system is even worse.
If such an Outcome takes place then it will be imperative to lighten up on Stock Holdings and perhaps to dump anything that is High Beta (Beta is a measure of how much a Stock Price tends to move in relation to the overall market - a Stock with a Beta of 2 tends to move twice as much as the market - i.e. if the FTSE100 moves 2% then the Stock would move 4%.) and active Hedging using Index Shorts via Spreadbets or ETFs (Exchange Traded Funds) will be useful. As always a Diversified Portfolio will give some cushion and this will be particularly important to balance out the Winners and Losers of any Outcome.
Frankly I very much doubt it will come to this because although they dare not say it, the ‘Powers that Be’ in the EU and the UK (and they will be getting advice from the US and bodies like the IMF as well) will be fully aware of the catastrophic collapse that would be caused by the UK crashing out of the Article 50 talks - no sides want this to happen because they are all Politicians and they know it will be impossible to get re-elected if such a failure of the Economic System happens again when memories and impacts of the 2008 Financial Crisis are so fresh in our minds.
Anyway, these talks are going to drag on and on and on and we will all be utterly fed up with them (if we are not already). I think that for much of the coming year or so we will see very little about the Talks and it will go on in the background - it will only be if and when major stumbling blocks of particular issues come up that we will see it in the Mainstream News.
Thinking of the Scenarios in this way makes things a lot easier - all I will be focused on is monitoring how the Talks are progressing and if I get a proper sniff that the Talks are at serious risk of a sudden and shock collapse, then I will be taking protective action on my Portfolio along the lines of Selling stuff and Hedging.
Right, that’s enough of that nonsense……
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