Ramifications of Brexit: What’s Next?

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Every time there has been a major news event like Brexit, some people have generated immense wealth, while others have lost it all. I believe people like Soros and Icahn have benefited greatly, since their short positions are well known.

The key question most investors want to answer is: What’s next?

Should an investor plunge in now, with all the mayhem, and start buying risk assets? That’ll look like a smart move if this downturn is short and the panic subsides, and things go back to normal.

On the other hand, if this is the start of many events, all of which are negative for investors, plunging in now could be the equivalent of catching the proverbial falling knife. And the knife could keep falling for some time to come.

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Personally, I have covered my short positions last Friday, when the markets dropped from the shock of Brexit. I have not added to any positions though. The big question now is how it’ll all play out.

Here are my thoughts on the consequences of Brexit:

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Division within the populace – Brexit has split the nation. With a mere 51.9% of voters choosing Brexit, against 48.1% in favour of staying, coupled with the fact that voter turnout is only 72.2%, the nation is almost split right in the middle.

Those who would prefer remaining, but did not turn up to vote, must be pondering what could’ve been.

Putting aside all the other issues, Britain has to eventually find a way to reconcile her populace or it could lead to much uglier consequences.

Already, there’s a petition by the Remain camp that has garnered over 1 million signatures, asking for another referendum whenever the winning camp has <60% of the turnout, and if the turnout is <75%

Interestingly, this whole referendum is actually non-binding, and the next prime minister actually can choose to go back to the EU to discuss new terms, and then bring it back to the public for a new vote.

This is highly unlikely to happen though, and in any case, the EU leaders are also unlikely to give concessions. If they do, that’ll encourage posturing amongst other EU countries.

Low interest rates – Brexit has derailed the US Fed’s plan to raise interest rates in the near future. Yellen is unlikely to want to rock the boat right now.

Political change – David Cameron has stepped down, so has the British representative to the EU Jonathan Hill. The new leader will likely need to call for elections soon, so as to get a mandate from the British people. If the new leader fails to win, expect much more uncertainty and volatility.

The new leader is likely to be Boris Johnson, a character who is erratic and volatile. Almost similar to Trump. Talk about uncertainty.

Also, the most recent reports are that Scotland wants to break away from the UK to stay in the EU. Talk about political change!

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Currency – Of course we’ll have to expect the pound to stay subdued for a while to come. The USD will strengthen in the aftermath of Brexit as investors flock to the relative (and supposed) safety of the USD, but longer term, it’s pretty uncertain.

Property – The most obvious factor is the weakness of the pound. Singaporean investors or companies with exposure to Britain, will suddenly find that their investment has been decimated overnight. The value of the property, as well as the currency fx risks going forward, is something that companies have to consider.

I’d expect companies to be much more cautious when considering property development there now. KPMG predicts an immediate 5% drop in capital values in properties outside London.

My heart goes out to homebuyers who have committed to a British property just before this referendum vote.

Trade – The loss of a common single market for the British is perhaps, the largest and most detrimental consequence of Brexit. Although technically the divorce could take up to 2 years, EU leaders have already started calling for a quick decoupling, presumably to punish the British and make an example out of them to other EU members.

There is already talk in Netherlands about an exit as well, and the EU would be sure to dissuade any dissenters by making an example out of the British.

The US-EU trade deal will also likely be derailed or at least pushed back. The British will have to renegotiate new deals as a standalone entity. The US seems keen to do so, but the British will likely suffer reduced influence as far as trade is concerned.

Business – Several MNCs have previously indicated that they’d pack their bags and shift their HQ to other EU cities, notably Frankfurt, in the event of Brexit. It remains to be seen if this will happen.

I do forsee that some of these MNCs, particularly banks, will shift their HQ or at least divert manpower and resources towards other major European cities. The EU is a much larger and prized market than Britain.

Up to now, London is the financial heartbeat of the world, with the major banks having the passport to operate unfettered across Europe. If EU seeks to punish the British, they could simply limit the access of the major banks.

The major banks will likely shift to rival European cities such as Paris or Frankfurt. This does not bode well for the British economy and jobs.

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Immigration – Ironically, the British may face increased illegal immigration. There is a large refugee camp in the French-British border with many immigrants trying to cross the channel into Britain. The French have been limiting this according to an agreement with the British by conducting border checks.

With Britain out of the EU, the French are no longer obliged to do so. It’ll be the prerogative of the British to do so themselves.

Quantitative Easing – This is one of the reasons why I covered my shorts. Thus far, politicans have reacted to any major economic crisis by printing money. Different names, different programmes, but they all involve printing money and increasing liquidity.

I don’t agree with it, but politicians will do that anyway. It’s just the easiest thing to do.

Whichever way it’s done, increasing liquidity will at least in the short term, increase the prices of risk assets and flush out the shorts.

My Views

I noticed that major crises such as the 2009 GFC, usually arise from relatively “unseen” situations, or situations that are obvious only on hindsight. Even the recent sharp market corrections in the earlier part of 2016 was due to the Chinese equity market crash, which was somewhat unexpected.

IMHO, Brexit, although unexpected, is not going to be a precursor of a major GFC. (One caveat is that if this leads to more Euro countries doing their own version of Brexit, then all bets are off) Sure, there’ll be some contagion in the short term, which may lasts for weeks, perhaps even a few months, but when all is done and dusted, Britain alone does not control the world’s economy.

Everyone will move along in a few months when this hype is gone, and the British will be left to deal with the consequences themselves. Not too long ago, Greece was the poster bad boy. I noticed there has been literally NO mention of Greece despite Brexit coming true.

As an investor, I don’t think I can predict to an absolute certainty how everything will pan out. I do think though, that this will not be a situation whereby the markets crash to crisis levels, and a worldwide recession occurs.

So if this is not the situation, I’d rather cover my shorts, take the profits and accept that I’ll miss out on some of the profits if the markets continue to tank. In return, I’ll not have to face the equivalent of a short squeeze, if some stimulative event happens. For eg. if ECB announces some short term liquidity measures aka easing, the markets will respond strongly.

Meanwhile, if the markets do continue to crash over the next few weeks, I’m glad that I have the capital to allocate now and will be looking to buy risk assets. I’m not thinking of buying British equity per say, but a relatively short term trade in an MNC with british roots makes sense to me. With all this negativity, the share price would be low enough for a large MOS. MNCs are highly portable in this day and age. I don’t think a Brexit affects their European operations as much as it affects the jobs for the British.

Of course, any investment needs to fulfill the usual requirements of being a contrarian one, with deep value and preferably with a catalyst in the horizon. On the other hand, if I don’t find anything compelling, I’m contended to sit tight and hold on to my cash and wait longer. Afterall, my global macro opinion is that there’ll be much more of such volatility and perhaps a large GFC in 2017 and beyond, after the US elections in November.

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