The FTSE is in a bull run but most investment houses are predicting recession. So what has Brexit really done to the UK economy? John Greenwood investigates
The FTSE100 is in a bull market, and the FTSE250 is ahead of its February trough, while the Government’s cost of borrowing has fallen to an all-time low. Yet the pound is down 10 per cent, property funds are down 20 per cent, consumer confidence has taken a nosedive and the bond yield curve and countless investment houses, not to mention the Treasury, IMF and numerous economic institutes are telling us that a recession is coming.
So will the surprise referendum result be the blow to our economy that Project Fear said it would, or will, like the Y2K bug, life carry on and we will all one day come to wonder what all the fuss was about?
Choosing your evidence
Part of the problem in finding an answer to this multi-trillion dollar question is ‘cognitive dissonance’ – the tendency to absorb evidence that supports our view and reject evidence that does not. With so much seemingly contradictory market data around there is something for every creed of referendum voter to hold onto to confirm their original point of view.
Political leaders are telling us that the UK can look forward to a positive post-Brexit economy, although they have to avoid talking down the economy. But sharing their positive view is the UK’s favourite fund manager, Neil Woodford. Woodford predicts there will not be a recession, and that growth will continue largely unimpeded by the vote.
Speaking in the aftermath of the vote, Woodford said: “The economics of the UK over the long term will be uninterrupted by what has happened. This (the Brexit) is not going to change the fundamental trajectory of the economy over the next 3 to 5 years. We have certainly been cautious about the UK and globally for some time. I expect the UK will slow down a bit more than it would have done, but I do don’t expect a recession in the UK. That might be a bit controversial, because a lot of people are forecasting a recession. I do not think that we will see one.”
Woodford is correct in his assertion that a lot of people are forecasting a recession and material negative impacts from the Brexit vote. BlackRock, Amundi (Credit Agricole and Societe Generale), Aviva Investors, Royal London Asset Management, Investec and Julius Baer are just some of the money managers to put out statements post-Brexit that warn of an impending recession. Meanwhile Invesco agrees with Woodford that there won’t be a recession, although it does say that growth will be halved, while Rathbones predicts no recession and growth of between 0.5 and 1 per cent in the first two years.
Both sides can’t be right
“The real answer is that nobody knows, but somebody has got to be wrong,” says Hargreaves Lansdown senior analyst Laith Khalaf. “While the stock market is reacting positively, what the bond market is saying is very negative on the economy. The bond market is saying that that is not a stock market bull run being driven by earnings and growth, but it is being propped up by monetary policy.”
A FTSE100 bull market can be easily ascribed to the downgrading of sterling – if upwards of 70 per cent of earnings are overseas, then the number of less valuable pounds needed to buy those dollar assets rises. The Bank of England’s promise of more liquidity also doubtless helping share prices.
Despite the buoyant FTSE, Khalaf says: “Don’t forget there have been some big losers, including house builders and airlines. Even the FTSE 250 has a high degree of earnings overseas. But where else other than the stock market do you go? The stock market is the only game in town.”
Is the market telling us Brexit is bad for the UK?
Whenever sterling falls, the stock response is always ‘it is good for exports as it will stimulate manufacturing’ – but does it also tell us ‘the markets think Brexit is a bad idea’?
The weak pound is good for some and bad for others, and that doesn’t just apply to businesses. “We have one client whose fund was £300m pre-Brexit but it is now £320m,” says LCP partner Andy Cheseldine. “We have believed for a long time that sterling would devalue with regard to the dollar and have hedged schemes on that basis.”
But is the downgrading of sterling and the inverting of the bond yield curve proof that Project Fear’s predictions are coming true? Is sterling a better proxy for the state of the economy than the stock market, and is the market’s reaction evidence that Brexit is ‘a bad thing’?
Axa Wealth head of investing Adrian Lowcock says: “The trouble with the bond market is the yield curve is suggesting a recession. But the yield curve has struggled as an indicator of markets since the financial crisis. While I don’t think the UK will go into recession, though it is almost a question of semantics whether it goes into the technical recessional not, it will go into a slowdown. But markets are very contradictory at the moment – you have gold and shares both rising in value at the same time.”
So what is the market actually telling us about the Brexit decision? “The markets are telling us that it is bad, and the concern is that it will be negative in the short term,” says Lowcock.
“If you are in the UK, spending pounds, then you won’t notice anything different in the short term – in fact you may be better off if you were invested in stocks based overseas. But sterling is a better predictor of what the global economy thinks of the UK economy. And it is telling us that the economy is likely to perform less well,” says Khalaf.
Centre for Policy Studies fellow Michael Johnson says: “I think it is too early to say whether there will be a recession, or what the economic impact will be. Exports will be stimulated but the danger with constant devaluations of currency is it lets you out of jail when it comes to improving productivity. Devaluing the pound constantly is not good because it allows us productive companies to survive. A weaker pound delays reforms.”
So while the mainstream media points to the strength of the FTSE as evidence things are going OK, the majority view remains what it was pre-vote – that Brexit will cause a drag to the UK economy and probably push it into recession. What is considerably less clear is the extent to which this is the short-term readjustment that Brexiteers have predicted, or a long-term millstone around the neck of the UK economy.
“Businesses are stopping investing because they do not know the deal that the UK is going to get. It will take years for the full details of what the UK’s status will be to become clear,” says Willis Towers Watson senior consultant David Robbins. “There are two factors. Firstly, the short-term uncertainty; Secondly the question over the extent to which the UK will be held back because it will not be able to trade on such advantageous terms with the EU. The first of these questions will be resolved at some point. As to the second, it will be many years before we truly know what the impact has been.”
Post-vote voices predicting no recession
Woodford Investment Management founder Neil Woodford: “The economics of the UK over the long term will be uninterrupted by what has happened. This (the Brexit) is not going to change the fundamental trajectory of the economy over the next 3 to 5 years. We have certainly been cautious about the UK and globally for some time. I expect the UK will slow down a bit more than it would have done, but I do don’t expect a recession in the UK. That might be a bit controversial, because a lot of people are forecasting a recession. I do not think that we will see one.”
Rathbones: “Our own analysis – corroborated by economists’ consensus – suggests that uncertainty is likely to lower growth relative to what it would have otherwise been by around 0.5-1 per cent per year over the first two years. Of course, such forecasting is subject to considerable error; the effect of uncertainty could be double that, perhaps even tipping the economy into a shallow recession. However, a recession is by no means assured and this should be at the front of investors’ minds when assessing whether any post-Brexit adjustment of asset prices represents an opportunity or merely a sensible recalibration of the probability of a range of scenarios.”
Post-vote views predicting recession
BlackRock: “We see a risk of a UK recession and expect downgrades to an already poor growth outlook in the eurozone as the Brexit vote weighs on sentiment. We believe the UK’s divorce from the EU will be a long and messy process.”
“A significant slowdown in UK growth and material likelihood of a recession next year could threaten the financial outlook of pension scheme sponsors. We have halved our UK real growth forecasts to 1 per cent per annum for the next five years.”
Amundi (Credit Agricole and Societe Generale): “The British economy will no doubt sink into a recession in the next two years. Even if its growth stays in positive territory in 2016 and 2017, it is very likely to suffer at least two consecutive quarters of contraction.”
Aviva Investors head of global research Chris Urwin: “In the short term, uncertainty as to the UK’s constitutional arrangements and trading agreements will dampen activity and may trigger a recession by the end of 2016. In the longer term, the economy is likely to be impaired by reduced access to European markets and poorer demographics – weakening the UK’s fiscal position and potentially damaging productivity growth.”
Professor Ben Knight – Warwick Business School: “This latest piece of news confirms that the slowdown of the UK’s fragile recovery started before the Brexit vote.
“The first round effects of the Brexit decision seem likely to hit investment in buildings and machines, which will make matters worse. The only good news is the fall in the pound that may provide a lift to exporters, but is probably not a strong enough force to offset the move towards a further slowdown in the industrial sector.
“The expected impact of Brexit on financial services may worsen this slowdown into a recession, especially if it spreads to the service sector as a whole.”
Royal London Asset Management senior client portfolio manager Ewan McAlpine: “Gilt yields are now fully priced for a deep recession and longer dated bonds are becoming increasingly vulnerable to an increase in inflation.”
Investec Wealth & Investment head of UK equities research Guy Ellison: “The British pound (is) the clear loser in the turmoil of the referendum result, against the euro. While it has stabilised, it is still significantly weaker than it was beforehand. A weak pound offers some benefits for the UK as it faces a likely recession next year. Exports should become more competitive, especially to the rest of the EU, its main trading partner.”
Julius Baer chief strategist and head of research Christian Gattiker: “As a result of its vote in favour of leaving the EU, the UK is probably heading towards a recession.”