Understanding the Brexit impact on financial markets

‘The EU is going to play hardball with the UK’ – Steven Barrow – Standard Advisory London Ltd.

HANNA ZIADY: We’re discussing Brexit this evening, the outcome of the EU referendum held yesterday. I’m joined this evening by Steven Barrow who is head of G10 Research at Standard Advisory London Limited. He joins us on the line from London. Gary Booysen is here in studio. He’s portfolio manager at Rand Swiss and Wayne McCurrie of Momentum Wealth is staying with us for this discussion.

That vote, as I mentioned earlier was an incredibly close one – 48.1% to stay, 51.9% to leave. And perhaps I should say up front that to be fair – and of course my discussion with Wayne did allude to this – I am going to be asking a host of questions of my very intelligent and astute guests. But we don’t necessarily know yet what all of Brexit means and what its impact will be because the finer details of course are still to be ironed out.

So let’s start by understanding what some of those details are. The EU, the European Union is a 28-member partnership, 27 potentially after today, which began quite some years ago, after World War II, to foster economic and political cooperation. It’s a single market allowing goods and people to move around as if the member states were one country.

Now in terms of Article 50 of the Lisbon Treaty member states are allowed to withdraw from the EU, but that’s only been in place since late 2009 and no one has yet tested it.

Let’s start with Steven in London. Steven, it’s good to have you with us. Now as I understand it this process could take as long as two years and the outcomes really depend on what is negotiated between the UK and the EU in this exit. What are some of the key terms and conditions – I know there are many, but what are some of the key ones that will now need to be negotiated?

STEVEN BARROW: Well from the UK’s perspective the, call it the key issue will be access to the single market which basically means that the UK can continue to trade on basically the same terms with other EU countries as it has done in the past. The problem with that from the UK’s perspective is that if you continue to want that sort of unfettered trade you also have to allow unfettered access, migration across countries.

And of course as you’re probably aware the referendum issue in the UK has very much been run around the migration issue continuing from those who of course have wanted to leave the EU. And therefore we’re in a sort of difficult situation because the EU won’t let the UK have one without the other. If we want free, sort of an unfettered movement of goods, we’ve got to accept free movement of people and we won’t accept that. So that’s where the impasse is going to be and, as you say, it could take two years to sort that out, it could take a good deal longer.

HANNA ZIADY: Interesting you note the access to the single market. Of course, I read a note earlier today from Franklin Templeton to say that the UK has not had to negotiate a bilateral trade agreement since 1976 and of course one has to question how fast it can be done.

To give a bit of colour as to just how far the detail extends, the EU has more than 60 different agreements around the world allowing planes from the EU to fly over and land in other territories. The United Kingdom on the other hand has none, which shows the breadth of things that will have to be addressed.

Steven, I mentioned this earlier as well the fact that the EU may make these negotiations difficult for the UK because they don’t want to set a precedent that voting to leave the union comes without pain or consequence.

STEVEN BARROW: Yes, that’s right – exactly the same situation for instance as we’ve seen with Greece. And obviously Greece is a member of the Eurozone and a much smaller country than the UK of course, and a country that’s been under enormous pressure, and yet one that has not really had a lot of flak given to it by the EU. In actual fact the IMF has on countless occasions tried to get the EU to go easy on Greece and the EU has never really done that and nor has the ECB. And precisely for that reason it wants to make an example of Greece to other countries within the Eurozone – for instance that bailouts are not easy and debt can’t be forgiven.

And it’s going to be exactly the same case, as you’ve mentioned, with respect to the UK. Again, if I listen to the rhetoric of the leave campaign in the UK, a lot of it has been based around the argument that the UK is the fifth largest economy in the world, Greece isn’t even the fifth-largest economy in the Eurozone, and therefore the EU is going to be much kinder to the UK because of our size, because of the UK’s size relative to how it’s operated towards Greece.

But you can already see from the very limited comments that we’ve had coming out from the EU already but that’s really not going to be the case. The EU is going to play hardball with the UK and you could argue that maybe it’s sort of cutting off its nose to spite its face in doing that. But, as you mentioned what it doesn’t want to do is suggest to other Eurozone countries that leaving the EU is an easy option.

HANNA ZIADY: Briefly Steven, in your view – and I realise that I may be too soon to tell –do you think the UK and EU economies respectively will be worse off in terms of economic growth?

STEVEN BARROW: I doubt really worse off; it’s only really a question of how worse off. I think the UK economy will probably go into a recession. This is a big dent as far as business confidence is concerned which, to be honest, has not been great even going into this referendum. And that will have a spill over of course on the Eurozone. Perhaps the Eurozone won’t go into recession but there’ll be some damage.

The European Central Bank will probably have to ease policy again, as indeed will the Bank of England.

HANNA ZIADY: Speaking about easing policy, that was going to be one of my questions – both the Bank of England and the European Central Bank expected to do just that. There are some expectations that the BoE will cut its interest rates to zero and also introduce quantitative easing with the ECB similarly pumping some easy money into the system. Wayne, might we see some of that stimulus flow to South Africa?

WAYNE McCURRIE: If it affects sentiment and the actual economy is positive, clearly that will help South Africa. And we have seen flows in previous bouts of quantitative easing. South Africa, particularly, the resource cycle is far more important as far as capital flows into the country. And despite what’s happened today, that’s actually looking a lot more positive than it did six months to a year ago – and that is still more important for South Africa.

The UK will go into recession. No one is going to buy a house or buy a car or borrow money or build any factory or anything like that for a while now. People will just pull back because they don’t know what the future holds; it’s uncertain. So the UK is going into a recession and in the UK they’ve actually increased interest rates in the last while. They’re going to cut them to zero and they’re going to pump money in there. They’ve got no option, they have to do that. And that will help sentiment a little bit. It might even help stock markets a little bit.

But the UK is going to have it tough, make no mistake about it – it’s going to be tough. The joke going around today is: “What are the four most popular words in the UK at the moment?” And they are “Can we vote again?”

HANNA ZIADY: Very interesting indeed. Equity markets of course don’t welcome uncertainty, as we suggested earlier. Also if companies don’t invest then economies don’t grow and companies don’t grow and that’s also not good for listed stocks.

So a decreased appetite, perhaps, for equities, Gary? I’m not sure what your view is on this. Is this time for bonds?

GARY BOOYSEN: Potentially, but it’s really the time in the uncertainty and in the panic to look for those quality counters that you can perhaps pick up at a discount, because the selling looked pretty broad-based today and there were plenty of companies getting punished and maybe getting punished a bit unfairly. I think maybe we’re giving an impression, pretty unfairly, but taking opportunity in the risk-off scenario may be a way that you could boost up your returns in the equity market.

HANNA ZIADY: The EU and the UK are both very important trading partners of South Africa. Trading agreements with the regions may well need to be renegotiated, particularly between SA and the UK. That’s certainly an expensive and time-consuming exercise. There are certain outcomes that make this easier, such as if the UK were to join the European free-trade area.

Steven, I know you’re not an expert on South Africa and I know your focus is really on the G10, but is there any world in which you think that the renegotiation of treaties may be good for a country such as South Africa?

STEVEN BARROW: Yes, most definitely. It’s not as if this referendum in the UK has been about putting up trade barriers or increasing trade barriers where they might exist with countries in the EU or outside of the EU. So there’s no reason to feel that countries that might want to trade with the UK are going to be disadvantaged as a consequence of Brexit. Indeed, it may even be the case that if the UK’s relationship with the EU turns a little bit frosty as a result of trade, then the UK will have to look to do more of its trade with countries outside of the EU, as it has already been trying to do anyway.

So I think there’s no real reason to feel that there will be a disadvantage necessarily. There may well be an advantage for countries that are looking to export to the UK. The difficulty, as we mentioned before, is that this will take time and manpower. As you mentioned before, the UK negotiates its trade deals through the EU. It doesn’t necessarily have the manpower to do this itself and it will have to accumulate that manpower over time and that’s just one of the issues that will delay things.

HANNA ZIADY: What I found most interesting and perhaps quite sad today is that the polling data actually showed that those in the 18- to 49-year-old category were favouring a stay, the 18- to 24-year-olds overwhelmingly so. And those in the 50 and above category were voting leave, an overwhelming majority of these older than 65. In other words those who must live with this decision for the longest actually voted stay.

But let’s not dwell on that. We mentioned markets, currencies. Gary, investors may be panicking – as we have suggested that is the tendency. What would you say to the panicky investor?

GARY BOOYSEN: I would definitely say, as Wayne said earlier, this is not the time to re-jig your portfolio. You need to see where the chips are going to fall and the exaggerated reaction we got today was I think just because of the shock value of the announcement. So if we look at the volatility index yesterday, compared to what we had in August 2015 when we had the ructions in the Chinese markets, then the VIX spiked to 40 now. We were sitting at 18 yesterday. The market was not expecting this, there’s no question about it.

But okay, we did get a bit of a currency blowout today but with our market finishing what, down 4% or in that region, that’s two negative days falling 2% It’s not a dramatic movement and you really need to see how this is going to play out. Obviously nothing is going to happen for the next three months. David Cameron is going to still be in power and it’s really going to come down to how the unwind happens and, yes, definitely just don’t panic yet.

HANNA ZIADY: And we haven’t even touched on the fact that the British Prime Minister David Cameron did announce his resignation today. But unfortunately we are out of time.

I was hoping to touch a little bit on the rand, but the rand at this hour is at R15.01 to the dollar. It strengthened to below R15 to the dollar mark earlier on this afternoon, so certainly not a complete currency blowout by any means. But the bottom line, the headline message, do not panic.

Let’s all have a nice weekend and wake up on Monday morning and tackle this then.


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