The EU referendum result last week was certainly not what we wanted; and a cursory look at our portfolio will tell you that it is not what we expected. The potential exit of the United Kingdom from the European Union will damage the UK’s economic performance in the short and medium term. This is not because of any immediate change in the terms of trade between the UK and the Continent; even the Leave campaign is reversing sharply away from the prospect of invoking Article 50 of the Lisbon Treaty. But it is that frequent enemy of economic progress – uncertainty – that poses the greatest threat to short-term prosperity. With every passing day since the Brexit vote, events have compounded the nervousness around the political and economic direction the country is going to take. In the immediate future, hiring staff and capital expenditure decisions are the ones most at risk from deferral and cancellation. Until there is greater clarity over the future, corporations are unlikely to be signing off big cheques for anything other than a very short-term payback.
Brexit is likely to cost us all something in the short-term. Even the Brexiteers tacitly admitted this through the campaign. They claim long-term benefits, however, driven by a rejuvenated economy, freed from the shackles of senseless Brussels legislation would more than outweigh the immediate pain. Share prices are a market referendum on the EU referendum. They are clearly very far from convinced.
Today, we can hypothesise endlessly about the whys and wherefores of how we got to this position. The airwaves have been saturated by analysis, claim and counter-claim. All of this is natural given how momentous the last few days have been in a British political context. Has there ever been an event in any modern democracy that has claimed the head not only of its elected leader, but also that of his nearest political challenger? The fault lines along which political boundaries are drawn in the UK are shifting dramatically. It is likely to take years for new parties and factions to properly coalesce around the interests of individuals shaped by the globalisation and automation of labour. Equally, it is going to take years (perhaps even decades) to settle the UK into a new trading relationship with Europe and the rest of the world. Further, we implore Holyrood that Scotland needs no more referendums – no more political uncertainty. It is likely to take years before we know if this is the case or not.
Which means that we have to live – and invest – in the here and now. We can wail and gnash our teeth; but the rest of the world is going to carry on regardless. People will still need to eat, clothe themselves, travel to work, and drink alcohol (particularly after last night’s football result). People also need homes. We have been stunned by the stock market’s reaction to housing related shares post the referendum. There is, and will remain, a structural shortage of housing in the UK. Net migration has only a small part to play in that structural shortage. I have been covering the UK housing market for nearly 25 years. Throughout that time, the industry benchmark has been that the UK needs 200,000 new homes every year to meet increased household formation. Immigration is responsible for some of that demand; yet so is a growing population through ageing, smaller family units through divorce, and a tendency for children to marry later in life. There is also a process of replacing “worn-out” stock of housing no longer fit for purpose. To see how little influence net migration has on new house building, one simply has to look at the figures. In each of the years from 1994 to 1997, the UK almost hit its soft target of building 200,000 new homes. The net migration into the UK in each of these years barely registered at an average of less than 70,000 per annum. Yet, in 2010, the number of houses built in the UK collapsed to 137,000 – despite net migration being over 250,000. Irrespective of immigration, there is a structural shortage of housing in the UK. What has a much greater impact on house building and house prices is the supply and price of mortgage finance.
The share price reaction of the banks since last Thursday suggests the market fears a “Lehman-type” fall out post the referendum, which could lead to a retrenchment of lending into the housing market by the banks. We categorically do not believe that to be the case. Lehman paralysed a global financial system that was low on capital and transparency, and high on short term wholesale funding. Further, policy makers were flat-footed in providing the necessary liquidity to keep the system operating. None of these conditions exist today, particularly in the UK. Currency markets tell us the UK’s credit worthiness is collapsing. Gilt markets are telling us that we are one of the safest credits around the globe. The truth is somewhere in the middle. The UK has a 300 year track record of paying its debts. Whilst we may grumble about our taxes – as a nation we still pay them when required. We have a Central Bank that can turn on the printing presses if required. In the short term, the depreciation of Sterling relative to other currencies will exacerbate the trade deficit. Over the medium term it should help to repair it.
Above all, the UK is not a basket case. We have a well educated, flexible workforce, and world leading reputations in areas as diverse as financial services, media and the arts, medical research, and high-end engineering.
Share prices are starting to suggest that this counts for naught. The mid cap environment has been particularly savaged. As a result, we can pick up great businesses for prices that we have not seen for many a year. The events of the last few days have been truly momentous. The changes in day to day life, however, will emerge only slowly. The country’s entrepreneurial leaders will respond, adapt, and then thrive – as they have always done. We came into this period with a bit of cash in reserve. We will deploy it to back them in this.