Brexit vote suggests the trend towards globalisation is likely to slow

WHAT should investors do about the Brexit vote? Even stock markets do not yet seem to know what it means. But, there may be a bigger pattern to events that investors should understand. Brexit could mark a reversal in the longterm trend to globalisation.

The referendum vote has re-opened questions about the future of the European Union. Britain’s re-affirmation of identity could be seen as part of a rise in nationalism that stretches from India and Turkey, to Russia and the US. It reflects voter frustration with more than a decade of stagnant living standards in many countries, despite the recovery from the Great Financial Crisis, and strong stock markets.

Investors buy shares, not economies; since the crisis, stock market performance has outstripped economic growth.

Printing money via quantitative easing programmes has boosted financial assets around the world. Cheap money encourages company buy-backs, bids and mergers.

But what it has not done is had much impact on economic growth. Around the world, there has been a failure of productive capital investment, which has led to a lack of labour productivity improvement. This stagnation has put downward pressure on prices globally. Undoubtedly, printing money has benefited those who already own shares, bonds and property, but there is little evidence of a trickle-down.

By comparison, voters are rooted in the real economy and believe only a few are benefiting from this focus on monetary policy. This will drive voters to elect politicians with more focus on fiscal policy, and with a determination to hold central banks to account.

Central bankers think cutting interest rates to zero boosts consumer and business confidence. And, not content with zero rates, many bonds and central banks have now moved into a world of negative rates. To the public, all this is a sign the central bankers are worried. And the reaction to that by consumers is to save more, spend less. It seems monetary policy is itself encouraging this spiral into global deflation.

A move to fiscal policy – using tax incentives and regional policy – may bring surprises for investors. It probably means more stock market volatility. But investors may also need to accept the trend to globalisation could now slow. The familiar trend of increasing trade, competitive devaluations and ever-expanding multi-national businesses, may change.

That would cut world growth and bring in more specific country risk. It would represent a big change for stock markets – for years, many investment managers have based their investment strategy on global convergence.

With the failure of monetary policy, there is little room for banks to boost growth. The bill for the Great Financial Crisis has not shrunk since 2008, with huge debt and bad loans still on bank balance sheets.

In Europe, the banking risks look even greater. Banks in Italy and Germany have made little attempt to de-leverage. Unfortunately, interest rates at zero make most banks unprofitable. They have little incentive to lend.

If banks in Europe are not to see bad debts written-down, inflation is the only alternative. Yet, no economic policy seems able to deliver this. The EU has made great efforts to avoid write-downs with Greek debt, but may be forced to yield to the inevitable. A shock in Europe’s banks is still possible.

Downward pressure on prices globally may persist and investors need to consider the companies that can provide stable growth in this environment. Businesses in the tobacco and healthcare sectors for example, have performed strongly, but could yet move to higher valuations.

But, for businesses facing tough competition or with little control over pricing, there will be greater risk of dividend cuts. Investors should see deflation, the failure of monetary policy and income disparities as the big picture. Monetary policy has made investing look easy since 2009, but a new and more challenging landscape may lie ahead.

‘‘ Interest rates at zero make most banks unprofitable. They have little incentive to lend

Colin McLean is managing director, SVM Asset Management.