OCM Commentaries

Market Commentary – 21st November 2018

By November 21, 2018 No Comments

The UK’s exit from the European Union once again emerged as a key point of contention this week, asTheresa May presented her breakthrough draft Brexit plan to the House of Commons. While the initial market reaction to the deal was positive, with UK markets up on increased expectations of an orderly exit, positive market sentiment was quickly eroded by lack of support for the deal in the PrimeMinister’s cabinet. After a series of cabinet resignations: most notably the Brexit secretary DominicRaab, last Thursday morning, the Brexit divide now appears more evident within the conservative party, raising questions on political stability and the economic implications of a change in leadership given the current challenges within the party.

May’s plan faces serious criticism from all sides, culminating in calls for a vote of confidence in the leadership within the conservative party on Thursday, with Brexiteer Jacob Rees-Mogg leading the coup attempt. Key points of contention in the proposed plan are the continuation of a customs union with the EU, calls for a permanent solution to the Irish border problem, and the role of the European Court of Justice (ECJ) in UK law going forward. Despite the attempt last Thursday after a long week of political turmoil, Theresa May appears to have hung on to her leadership by a thread, however this week provided a stern warning to markets of the turmoil expected should the UK fail to agree an orderly exit from the EU before the March deadline. The situation became more perilous last night as the DUP refused to give the government their support on amendments to the budget, which is a worrying sign of things to come.

As an explanation of what could happen next, the Conservative party only holds onto power due to a“confidence and supply” agreement with DUP to support the government. If the DUP decide to notsupport the conservatives, then we could be facing an election. So far, many conservative politicians have decided to not submit a letter of no confidence in the prime minister and are putting pressure on her to try and reopen the negotiations and then give her some time to try and renegotiate. If though there became a clear choice get rid of Theresa May and maintain the support of the DUP or have an election and risk Jeremy Corbyn getting control of government then I fear Theresa May will be for the gallows.

Even then no one else really believes they will get a better deal from the EU because, as I have always said, the EU are not inclined to give us a good deal, because if they do then they open the flood gates. If Theresa May does get this deal to parliament then the timeline is as follows: –

  1. Summit on the 25 November in Brussels where leaders will be asked to approve it;
  2. After the summit the deal will be laid before parliament and due process followed:
  3. If process is followed the motion will go before parliament on either week commencing 3rd or

    10th December;

  4. The debate and process to follow means we will have a meaningful vote on either second or

    third week of December, but it could carry on into January;

  5. After this assuming a deal is put through the withdrawal agreement has to pass the house

    without amendment;

All in there is no support and the maths does not look good for this or any deal to get through parliament as the Conservatives are as always split between the “Brexiters” and the “Remainers” sono one will be appeased and as neither side has a majority a compromise seems impossible. Theresa May cannot rely on Labour supporting her as they seem unwilling to support any deal unless the deal passes there six tests, which are impossible.

What next therefore?

Defeat in the house of parliament for her deal could well lead to May resigning or to a meaningful leadership challenge. If there is a challenge after a parliamentary defeat, it would stand a greater chance of success than one in the next few days. If she falls, her party would need to fast track its process for choosing a leader, normally a couple of months, into a few weeks, given the urgency of Brexit. But the arrival of a new leader would not change the parliamentary arithmetic of the Brexit deal. The EU would not reopen the withdrawal agreement, whatever a new British prime minister wanted. And any prime minister who pushed for no deal would be defeated in Parliament, since a large majority of MPs are determined to avoid that outcome. Therefore, the new prime minister, whatever his or her political slant, would be faced, like May, with the difficulty of getting the deal through Parliament. The EU might indulge the new leader by allowing him or her to tweak the political declaration, to make it more appealing to one or other faction in Parliament. But MPs would have to vote again on essentially the same deal, and there would remain a large chance of it being defeated once more.

If Parliament votes against the deal, there are just five possible outcomes.

1. No deal – First, the default option is for the UK to leave without a deal. This outcome could come in the form of a managed no deal, whereby the two sides acknowledge the UK’s inabilityto ratify a withdrawal agreement, at least for the foreseeable future, but take steps to avoid the worst sorts of disruption for businesses and citizens. There could be mini-deals onaviation, citizens’ rights, insurance contracts, border controls and so on; the UK might pay part of the £39 billion that it has promised to the EU, to generate goodwill. The European Commission has sought to prevent discussions between the member-states and the UK on ways to reduce the pain of no deal, so that that outcome does not become attractive to the UK. If no deal really became likely, however, the EU would probably soften its approach. But no deal could also turn out to be acrimonious and very hard, with the UK paying no money and the EU rejecting mini-deals. Such an outcome is unlikely, since those responsible for thechaos would soon become unpopular with their voters; also, the financial markets’ reactionwould be more extreme, with a sharp weakening in the value of the pound. Neither the EU nor the UK – unless by some chance the prime minister was an extreme Brexiteer – would welcome no deal, and if that outcome loomed, they would probably try to continue negotiating to find an alternative. But no deal cannot be ruled out if Parliament votes down May’s package. Back to the EU to get a better deal.

  1. Renegotiate – Option two is that Parliament urges the British government to go back to the EU and achieve a better deal. The Labour Party takes this line, arguing for the UK to negotiate a permanent customs union. And there is a majority in Parliament for a softer Brexit, including a customs union and, for many MPs, a future relationship that is closer to the Norway model than to the Canada model. Because the EU wants to encourage Parliament to vote for May’sdeal, the Union says it would not agree to reopening the Brexit package. It certainly means that when it comes to the withdrawal agreement, which is a treaty. But it might agree to revise the political declaration, which is non-binding and covers the future relationship. If the UK shifts its red lines, the EU could agree to a political declaration sketching out a closer future relationship. Such a deal would still incur strong parliamentary opposition from Tory Brexiteers who oppose the withdrawal agreement and its backstop but would be more likely to pass muster with Labour MPs. A variant of this option is discussed by increasing numbersof Labour and Conservative MPs: going all the way to ‘Norway’.

    The UK would join the European Free Trade Association (EFTA) in order to remain in the European Economic Area (EEA) post-Brexit, and thus in the EU’s single market. The case forNorway is that both Leavers who want a Canada-style FTA and Remainers who want to stay close to the EU would prefer it to the chaos of no deal. The Leavers would see it as an interim step for a few years – and more comfortable than the withdrawal agreement’s transitionalprovisions – while they negotiated an FTA. The problem is that neither the EU nor the EFTA countries want the UK to be in the EEA for just a few years. They would be relaxed about the UK seeking to join in perpetuity, but doubt that the UK political class would tolerate the conditions on a permanent basis. They are probably right that Parliament would find it hard to accept single market rules without the UK having a vote on them, free movement of labour and large payments to the EU budget. In any case the EEA route would require a lot of treaties to be rewritten and ratified over a long period.

  2. A general election – A general election could become attractive. The Labour leadership would like this, believing it could win. This third option becomes attractive if there is a blockage in Parliament and renegotiation has failed, and the UK is drifting towards the ‘cliff edge’ of a nodeal Brexit. The Labour leadership would like this, and believe there is a high chance of it happening, believing it could win (although some Labour MPs are unenthusiastic, since they do not want to see a government led by Jeremy Corbyn). Some Tory MPs want to avoid an election, in case they lose their seats. Many others would be horrified at the thought of an election potentially making Corbyn prime minister. But the prospect of no deal also horrifies many Tories, and if it loomed some of them would favour a leadership election and maintaining the support of the DUP, as a means of preventing that outcome. Even with the Fixed-term Parliaments Act, a motion of no confidence or a vote of two-thirds of MPs can trigger an election. An election would shake up the parliamentary arithmetic and perhaps enable a deal to pass. But if the voters returned a similar Parliament, which they might, MPscould still reject May’s deal – whether she remained prime minister. The possible arrival of a Labour government would be significant. Such a government would, at the very least, seek a significantly softer Brexit, and could perhaps seek to hold a new referendum.
  1. Second referendum – The fourth option is a so-called People’s Vote. The case for a secondreferendum is that when the British voted in June 2016, they had a choice between the EU they knew, and an abstract Brexit that was never defined. Now they know the reality of the deal that is available, and it is in many respects less attractive than the one they werepromised. So they deserve a final say on whether Brexit should proceed. ‘If public opinion shifts decisively towards Remain, more MPs will be emboldened to favour a referendum’. The case against a People’s Vote is that electors made a clear decision in June 2016, that a second referendum would be horribly divisive, and that the result – whichever way it went – would probably be close and thus fail to settle the issue definitively. Some critics argue that anotherreferendum would undermine trust in Britain’s democracy and lead to civil unrest. Quite a lotof Remainers are reluctant to back a new referendum on the grounds that it could easily be lost. Last summer the chances of this outcome seemed minimal. They have grown because the Labour Party has moved towards a more positive view: it says it wants a general election,but that if that is not possible it will back a People’s Vote, and that one option should beRemain. Also, some leading Conservatives, such as Jo Johnson and Dominic Grieve, have come out in favour of a referendum. If public opinion shifts decisively towards Remain, more MPs will be emboldened to favour a referendum.
  2. The national interest – The fifth and final option is that, faced with no deal – with neither a renegotiation, nor an election, nor a second referendum proving viable – MPs swallow theirscruples and vote for May’s deal, in what they consider to be the national interest which iswhat we think Theresa May is hoping for. Options two, three and four would require some extension of Article 50, to give the UK more time to sort itself out. May has said firmly that the government will not request an extension, but she could always change her mind (as she did on whether to hold a general election last year). Any EU decision to extend Article 50 would require unanimity among the 27 governments.

    The EU would be reluctant to take such a step, particularly beyond mid-May 2019, because ofthe European elections later that month. Britain’s seats in the European Parliament have already been reallocated and it would be legally complicated to keep the UK in the EU beyond the elections. But if the EU really wanted to prolong British membership by several months, there could be ways around the European Parliament problem; for example, the UK could appoint MPs as MEPs on an interim basis. Option two, renegotiation of the political declaration, would probably require just a short extension, if any. But if the UK wanted to hold a general election or a referendum, the prolongation would need to be for several months.

    One cannot be certain how the EU would react to such a request from a British government. If the request was perceived as frivolous, for example for the Tory party to find a new leader with a new plan, the EU would probably say no. But if the request was serious – the purpose being to hold an election or referendum that might stop Brexit – EU leaders would probably agree. Virtually all of them would be happy to see Brexit reversed.

Summary

Tensions remain on both sides of the negotiation process, and we will know more this time next week as Theresa May will have gone to Brussels and we will know whether on her returns she maintains the support of five members of her cabinet that he has so far maintained. There are also issues in Europe with Spain saying they do not like the deal over Gibraltar etc so all in all we see is more chaos ensuing for the next three to four weeks as regards to the UK and the impact on sterling.

Economics

We are still seeing positive economic data and despite ongoing instability in the global stock markets and concern over the rate of growth in 2019 and 2020, there is a still a great deal of optimism in the US that the global economy has some room to run. We are also starting to observe the 10 years US government debt yield fall back towards 3% from circa 3.3% which is a good sign. In many ways the fear created by Trump and trade wars is exasperated by investor fear that we are at the end of the expansion phase in the cycle and that the US economy is slowing down too fast because the US Fed Reserve will continue to raise interest rates.

The US is without a doubt still a strong economy with strong growth projections. Headline readings on retail sales and consumer process are slightly exaggerating the strength in consumer confidence from a spending and inflation perspective. Consumption is still solid but slowing, and inflation remains tame. The US continues to outperform other nations. Growth in Germany and Japan turned negative in the third quarter and activity is still getting weaker in China. It is anticipated by Economists that global growth should rebound in the fourth quarter, even as activity in the US slows. Against that backdrop we are seeing volatile markets but as yet we are not seeing the structural slowdown, we expect to start coming through in 2019. As always with our thesis if the US Fed decided to not raise rates in December or Trump agreed a deal with China that could be a catalysts to stay invested longer than we anticipate and always we remain flexible. Today though we remain invested and have balanced portfolios with equity and non-equity as noted below in the portfolios and the returns when compared to the indices over the same period.

For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.

Model Portfolios & Indices

Over the last week we have seen most of the indices that we track follow a downward trend again.Asia has seen most of the impact and Japan’s Nikkei index has been pulled down by auto giants Nissanand Mitsubishi following the arrest of Carlos Ghosn (head of Nissan-Renault-Mitsubishi alliance). Technology stock were the main drag on market performance this week. Most global indices bar the US are down circa 10% against a backdrop of continuing economic expansion which is to be honest a surprise and has bene caused by what are in the main political headlines. We have been seeing markets fall from record heights as they were kept buoyant by strong investor sentiment. Investors also remained nervous about US-China relations after a messy conclusion to the weekend’s Asia- Pacific Economic cooperation summit, where both countries attacked each other in speeches. In the UK, Brexit uncertainty weighed on markets, with political noise reducing over the week. Market risks remain as movements have predominantly driven by politics rather than the economics.

Over the past week, the model portfolios have mitigated the fall in the equity markets and have capped some of the losses noting if the losses seen today continue through the week into next then we would expect to see the portfolios showing a higher negative next week. We will continue to look at the model portfolios and implement changes as and when the data suggests, however remain fully invested awaiting an expected rally in equities in the last weeks of the year.

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Important Information

The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.

This Day in History

On this day in 1984, McDonald’s made its 50 billionth hamburger.As always have a wonderful week and stay safe.
VBW

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