Brex­haus­tion

Financial Mirror (Cyprus) - - FRONT PAGE -

Ana­tole Kalet­sky’s book was the source of much heated de­bate. And it is prob­a­bly through the prism of this be­lief in the tech­no­cratic classes that in­vestors’ re­ac­tion can now be judged. In­deed, there are two pos­si­ble log­i­cal re­ac­tions to the Brexit vote:

1) Fol­low­ing Brexit, OECD pol­i­cy­mak­ers will re­dou­ble their mar­ket price ma­nip­u­la­tion ef­forts. We should thus ex­pect more QE, more ZIRP and NIRP for longer, in­clud­ing per­haps from the US. In this en­vi­ron­ment, there are few rea­sons to be­lieve that the US dol­lar will surge (some­how still a core mar­ket be­lief—and on that note, we would high­light that, dev­as­tat­ing though news of Brexit was for the over­all Euro­pean Union, the euro has yet to flirt with the lows seen in March 2015).

As the Fed­eral Re­serve goes back to sit­ting on its hands, and the US dol­lar con­tin­ues to range-trade, emerg­ing mar­ket cen­tral banks (which saw mon­e­tary con­di­tions tighten in rel­a­tive terms be­tween 2011 and 2015), will now cut rates as ag­gres­sively as ev­ery­one else. EM bond yields will col­lapse, while com­modi­ties will con­tinue to hold up (in­ter­est­ingly, un­like in 2008, oil did not fall hard on Fri­day) and gold will con­tinue to out­per­form.

In this en­vi­ron­ment, EM in gen­eral will catch back their five years of post-2011 un­der­per­for­mance (when EM and OECD cen­tral bank poli­cies di­verged).

2) Fol­low­ing Brexit, pol­i­cy­mak­ers will freeze like deer in head­lights and start to ac­cept that the poli­cies they have fol­lowed, by ex­ac­er­bat­ing wealth dif­fer­ences, have set them straight on an elec­toral hid­ing to noth­ing. Worse, the tech­no­cratic classes may start in­fight­ing in a bid to sur­vive (for ex­am­ple, in an at­tempt to pun­ish the UK, they could im­pose tar­iffs and fall back into pro­tec­tion­ism). Al­ter­na­tively in­cum­bent politi­cians could lose elec­tions and be re­placed by a new breed, as we are wit­ness­ing in England, and also pos­si­bly in Italy (with the elec­tion of Five Star may­ors in Rome and Turin — wealthy Ital­ian cities not usu­ally as­so­ci­ated with the per­ceived repro­bates who voted “Leave” in Bri­tain) and to an ex­tent in Spain (although the rad­i­cal Pode­mos party per­formed less well than ex­pected in Sun­day’s elec­tion, the vote seems to have solved lit­tle. Spain ap­pears as un­govern­able now as be­fore the elec­tion). And the pur­pose in life of this new po­lit­i­cal breed will not be to un­der­write the price of fi­nan­cial as­sets (whether bonds, real es­tate or equities) and to pro­long the sta­tus quo. Need­less to say, in this sce­nario (the sce­nario that most in­vestors fear to­day), over­val­ued as­sets de­pen­dent on cen­tral bank liq­uid­ity are very much at risk.

These in­clude eu­ro­zone pe­riph­eral bonds, JGBs, real es­tate in most fi­nan­cial cen­ters (whether Lon­don, New York or Hong Kong), the eq­uity value of banks (as banks could eas­ily be na­tion­alised) and of course US equities (where rel­a­tive val­u­a­tions re­main very punchy).

Un­for­tu­nately, as Ana­tole Kalet­sky pointed out on Fri­day, the vis­i­bil­ity be­tween these two al­ter­na­tive paths is clouded at best, as so much will de­pend on pol­i­cy­mak­ers’ re­sponses, and on the bal­lot-box. Worse still, opin­ion polls and bet­ting lines may prove to be very im­per­fect guides, as was shown Thurs­day night. Given the un­cer­tain­ties sur­round­ing the Span­ish, French, Ger­man and US elec­tions, this new re­al­ity will most likely cur­tail an­i­mal spir­its among en­trepreneurs and busi­ness­men over the com­ing months (at the very least). With that in mind, in­vestors should look to con­cen­trate their port­fo­lios on as­set classes that do not risk dec­i­ma­tion should one, or the other sce­nario un­fold.

To start with, this means avoid­ing any as­set trad­ing above its his­tor­i­cal long-term val­u­a­tion (un­for­tu­nately, to­day this in­cludes most OECD gov­ern­ment bonds, OECD eq­uity mar­kets and OECD real es­tate mar­kets, as the whole point of the re­cent pol­icy was to boost OECD as­set prices). It also means ac­knowl­edg­ing that gold, as one of the few as­set classes that ben­e­fits from ei­ther sce­nario, is now in a struc­tural bull mar­ket.

Fi­nally, it pos­si­bly means con­cen­trat­ing on own­ing as­sets that could po­ten­tially ben­e­fit from new mon­e­tary and fis­cal stim­u­lus with­out be­ing un­duly pe­nal­ized by OECD pol­icy un­cer­tainty (EM equities? EM bonds? EM cur­ren­cies? Cana­dian equities and the Loonie?).

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