Monday, 19 December 2016

This was my Market Report 6 months ago... (Before the Referendum).

The UK markets have been hit hard by the threat of leaving the EU. The consequences, at least in the short-term would be a short sharp fall in UK stocks and Sterling. Depending upon what happens to the necessary capital flows which fund our current account deficit, (as well as our trade and fiscal ones), we might suffer an interest rate shock too. If the Foreign direct investment dries up, the UK may suffer a prolonged period of stagflation, falling currency and higher interest rates, choking off the recovery. If foreign capital flows do not dry up, then the recession or slowdown will be much milder. The fear of this outcome therefore has held markets back, even as US jobs data, and even Chinese numbers have surprised on the upside.
It is unusual for political events to so impact the markets, but we don't even know if 'Leave' would mean leaving the Single Market (Gove and the EU seem to say 'yes', a lot of Leave campaigners say 'No') and the government's contingency planning is silent on the issue. It is possible we could leave the EU but remain in the EEA which would be far less disruptive. Markets do not react well to not knowing such crucial bits of information.
So, the outlook is utterly dependent upon a "Known unknown" (the referendum) followed by an "unknown unknown" (how foreign capital reacts) to use Donald Rumsfeld's unfairly mocked phrase.  It's not even clear overvalued gilts would make a safe haven in the event of brexit, as if Foreign Direct Investment dries up, interest rates will have to rise. Only index-linked offer much of a safe-haven, but they seem overpriced. There is much else to report, but this month, it simply doesn't matter.

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