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Hard Brexit demonstration potential?

13 July 2018

What a week of drama and upset! For all the drama in the football, the political and global economic side were even more dramatic – at least from an investment managers’ point of view.

It was suggested last week that the UK government may experience some staffing changes, even when it looked like Theresa May had finally managed to rally her cabinet behind a more economically pragmatic Brexit course. In the overseas press, the resignations of Davis and Johnson over the weekend and Monday were therefore seen as a major setback to May’s leadership. But in the UK, it appeared to be interpreted more as a chance for stabilisation and at long last the possibility of beginning negotiations with the EU rather than having them primarily in the cabinet.

Together with the publication of the government’s white paper / plan for the UK’s Brexit, it now seems almost inevitable that there will not be a substantial break away from the EU when Brexit formally occurs in March 2019. Instead, and as we have now predicted for a while on these pages, it will be a rather soft affair initially, with everything else being developed, negotiated and executed over many years thereafter. This should effectively allow the UK to exit without a sudden shock to businesses and travel while initially at least continuing to enjoy the benefits of being a member of the world’s largest free trade zone for a while longer.

Speaking of free trade benefits, Donald Trump’s decision to engage the rest of the world in a full‑on trade war may actually provide us with a live demonstration of the economic impact of having to trade under significant tariff burdens. The real drama was not Trump’s ability to absolutely upset every one of the US’ hitherto allies, but his insistence on escalating the trade war with China. Knowing how sensitive the Chinese public is to any perception of being pushed around by imperial powers of old, it would seem to us that he may have to go rather further down the road of confrontation than he believes. The November US Midterm Elections also provide us with a time frame of how long it might last until he can reign back in trade hostilities without losing face with his electorate.

It is common knowledge that there are only losers in trade wars. This may also explain why stock markets still refuse to price in any collateral damage that would occur to the US economy; they don’t really think Trump will go through with it . China’s current stock market correction is unlikely to be a one-sided reflection of who investors see as the likely losing side, but much more the manifestation of slowing growth in China and a realisation that this time the Chinese government is less likely to prop up markets through excessive demand stimulus as they have in the past.

All in all then a mixed picture. A somewhat improving near term outlook for the UK, but a distinct risk if global economic shock on the global trade horizon. We have used the week to take stock of everything that is known, reported or projected and have weighed it against our own insights, experience of 30 or more years in economic and capital market dynamics and investment portfolio management knowledge. This will lead to some allocation changes over the coming weeks, although perhaps less drastic than some readers may expect given the drama described above. After all – our main experience is that in the end, outcomes tend to be much less dramatic than what we may come to expect when we play through everything that could possibly happen. For more please see the main document this week for our investment strategy update.