Full English BREXIT

Strategic Insights: October 2019 -- By Strategic Frontier Management

Citizens of the United Kingdom voted in June 2016 to Leave the European Union (EU). It was a surprising result given few expected a 52-48 majority of voters to seek EU independence. The referendum reflected voters’ dissatisfaction with dysfunctional, undemocratic, and costly EU bureaucracy needing reform. Membership in the EU no longer serves the UK’s best interests.

We published British Independence Day on June 24, 2016, which offered a few bold forecasts: (1) Extended BREXIT uncertainty can adversely affect both the UK and EU economy, diminishing foreign investment, (2) UK economy, equities and currency can perform at least as well as for the EU, and (3) UK should realize positive economic and fiscal benefits bolstering potential growth and global competitive advantages with greater independence of trade, tax, and regulatory policy. The third insight remains key to the UK’s post-BREXIT future, overwhelming short-term costs of transitional disruption and uncertainty. Our outlook for the UK’s economy was quite the opposite of apocalyptic predictions.

The UK has greater negotiating leverage given their trade deficit with the EU, which has more to lose if existing EU free trade is no longer extended to the UK. In 2018, the UK had an overall trade deficit with the EU of -￡64 billion, despite a ￡29 billion trade surplus in services offset by a ￡93 billion trade deficit in goods. The UK runs a trade surplus with only Sweden and Ireland, but Germany, Spain, and Belgium have the most to lose. Composition of future EU trade will depend on what kind of post-BREXIT agreement is reached, but financial services remains critical to about 80% of the UK economy reliant on services. UK exports may be overstated, and the trade deficit even greater, given shipments transiting Rotterdam before reaching non-EU destinations. EU export growth shrunk -5.3% over the last year, yet the UK economy has performed admirably, despite the transitory disruption of BREXIT uncertainty.

The paradox is that the further the British pound falls, UK export competitiveness increases and currency translation boosts UK corporate earnings. This virtuous feedback of the currency’s invisible hand likely has created a floor under the British pound around $1.20/GBP. We believe BREXIT uncertainty likely restrained EUR/GBP, but GBP could strengthen beyond 1.3-1.4 with BREXIT clarity. Global economic conditions, including in the UK, remain cyclically favorable to absorb a transitory disruptive shock. Once BREXIT is in the rear-view mirror, we expect UK pent-up consumption and investment to accelerate. Risk premiums in the UK’s equity and bond markets could eventually also diminish, as real growth increases and investors focus more on fundamentals. A Full English BREXIT should increase global economic and capital market divergences, as well as increasing tactical opportunities and international diversification.

BREXIT voters identified with critical issues: (1) Reassert sovereignty and self-determination, (2) Protectionism of the EU’s “precautionary principle” and harmonized regulation impeding global competitiveness and innovation, (3) Undemocratic bureaucratic, judicial, and political deterioration, (4) policy reform needed to restore UK economic productivity and potential growth. These issues reflect global anxiety of lagging economic potential evident in rising nationalist and libertarian challengers. Continued EU membership is estimated to cost ￡1B/month to remain, so it is time to get beyond the uncertainty and settle BREXIT trade, defense, residency and economic issues.

Our conclusion is that we believe the UK needs BREXIT and has the sovereign right to Leave the EU with or without the EU’s consent. We think the UK has more negotiating leverage in the Separation Agreement and future negotiations than assumed, if given political room to maneuver---and Her Majesty the Queen tipped the balance of power for BREXIT and post-BREXIT agendas in her recent Queen’s Speech. Continued timeline extensions are in no one’s best interest, as political and economic uncertainty has weighed on all of Europe. The UK can no longer afford to remain dependent on failing economic and ideologic policies of this political union.

Far from flourishing, the EU has become economically inefficient and uncompetitive due to its bureaucratic institutions—from governing the European Union to European Central Bank policy, and the EU’s judicial organization. And the Euro continues to weaken as investors' discount future growth. Monetary and European Unions must reform or they will diminish in relevance, as other countries choose self-determination over collective democratic socialism (or mixed capitalism) and borderless chaos. How many times must we choose the wrong road, ignoring history? We expect the UK to flourish over the next decade with a Full English BREXIT of new found independence, but after three years, now it is time to get on with it.

Disclaimer: This publication is for general information only and is not intended to provide specific advice to any individual. Some information provided herein was obtained from third party sources deemed to be reliable. We make no representations or warranties with respect to the timeliness, accuracy, or completeness of this publication, and bear no liability for any loss arising from its use. All forward looking information and forecasts contained in this publication, unless otherwise noted, are the opinion of this author, and future market movements may differ from expectations. Index performance or any index related data is provided for illustrative purposes only and is not indicative of the performance of any portfolio. Any performance shown herein is no guarantee of future results. Investment returns will fluctuate, and the value of holdings may be worth more or less than cost. ? Strategic Frontier Management (www.StrategicCAPM.com) 2019. All rights reserved.