What Brexit's unknowns mean for investors

There is no reliable way to incorporate the upcoming Brexit upheaval into a view of what price should be paid for investments
June 21, 2017

What a mess. A snap election has sown confusion just as Brexit moves to the top of the political agenda, where it will remain for years to come—whoever is in charge. A crucial process is now highly uncertain and our negotiating hand looks very much weaker. Investors and markets seeking certainty on the terms of our departure will have to wait and although hopes may rise for “softer” outcome major risks remain.

In the areas I look at, any loss of European Union funding for British venture capital investment (equivalent to a third of the total committed from 2011-15, according to the FT) will have to be made up; as will any decline in European research funding for British universities. This spending fuels innovation and ultimately creates jobs—we have no choice but to continue.

Equally, the Conservatives’ aspiration to cut immigration leaves many businesses facing nasty skills shortages that would stunt their growth. Modern high-value economies depend on skilled individuals—arguing that we should impose an arbitrary ceiling on our access to the world’s talent pool, rather than one that bears some relation to our economy’s requirements, is foolish, even allowing for its value as election campaign rhetoric.

Well before we went to the polls it was obvious that taxes in the UK must rise to prevent vital public services from deteriorating beyond the point of no return. This is partly because the UK’s working-age population is shrinking, relative to those too old or young to work. A smaller proportion of people working and paying tax inevitably equals more tax per head. On top of this we must also fund our eventual EU “divorce settlement.” Even if the mooted €100bn bill is bargained down, it will absorb scarce cash.

For all these reasons, the approaching reality of Brexit is a worry. But what’s worse is much remains unknown and unknowable. For investors, this is another of those huge and extremely complex events whose effects are both far-reaching and impossible to forecast, leaving no reliable way to incorporate the coming upheaval into our view of what price we should pay for investments today. So where to look for value? I suspect that UK exporters, especially those with valuable intellectual property, could perform well in this tricky period especially given the doubling in last year’s Autumn Statement of the risk capital available to support them through the UK’s export credit agency. However, businesses that depend on the confidence of the increasingly squeezed and taxed British consumer will probably find the going tough. Ultimately, however, these are just best-guesses. If the stock market looks unruffled, it could be because investors believe there is nothing to worry about, but it could equally be they have no clue what will happen and so no basis on which to respond.

In July 2007—on the eve of the financial crisis—Chuck Prince, then-chairman of the giant US bank CitiGroup, admitted: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Prince summed up how hard it is to know when the threat of trouble ahead has risen too far and the time has come to leave the dancefloor. Ten years on, his point once again is well made.