Brexit crystal ball gazing has become just too hard
Opinions still abound as to what happens next, but the only sure thing so far, is uncertainty is here for a while
The Brexit vote has passed us by. The immediate shock has gone and the implications are so far into the future that any forecasts can go into the “too hard” pile.
G20 policymakers were fretting only last week that Brexit was likely to “heighten risks for the world economy”. Yet it is still a pretty nebulous risk when even the president of Germany’s central bank, Jens Weidmann said, “there were no signs yet that economic development in Europe had been affected”.
Pressure is easing on the Japanese yen and gold, the classic “risk-off” havens, as markets figure that the impact of Brexit on the rest of the world is likely to be covered by rounding errors.
Yet Brexit, like Grexit before it, will hang around like a bad smell.
As Philip Hammond, the UK’s Chancellor of the Exchequer, admitted: “The reality is there will be a measure of uncertainty continuing right up to the conclusion of our negotiations with the EU.”
In Britain, there is no doubt that economic activity has been deferred — and in economics, deferral means slowdown.
A special GfK consumer confidence survey fell a big eight points to minus 9 (the highest ever was an index of 21.) The latest monthly survey by the UK Confederation of British Industry survey shows expected orders falling to minus 4 in July (from a minus 2 index level), and expected output falling to just 6 in July from 23 in June.
An even bigger blow was the UK’s purchasing managers survey (by IHS Markit) falling a massive 4.9 points to 47.4, forecasting a recession in services, with new orders falling the fastest in seven years and sentiment the most ever.
Germany meanwhile rose to 54.6 and even France showed a tiny expansion.
These are forward-looking sentiments, of course, and Michael Taylor of Coldwater Economics has observed a tiny correlation between the PMI survey and the eventual official figures. But when the falls are this big, it might mean something.
Investors look closely at these leading indicators for a glimpse of the future, and for anything that may suggest that the outcome is radically different from expectations.
Taylor looks at economic shocks and surprises defined as being outside one standard deviation of the normal series. The UK services PMI figures were a negative shock, and the German PMI figures a pleasant surprise.
Indeed over the last year, the Coldwater Indices show a world that is not looking too bad with surprises exceeding shocks in the US since January, and Asia since March.
Even sluggish Europe was doing well until the end of June when it began reversing its positive trend as Brexit struck.
Overall, Coldwater’s four-week index of shocks and surprises is at its highest since December 2014. The Citi Economic Surprise Index for China also appears to be flattening out, after a period when the light at the end of the tunnel was the train coming.
The other leading indicator that investors follow is company earnings, as profit is a key driver of stock prices. With a quarter of S&P Index stocks reporting, US companies are showing earnings better than expected. They are estimated to decline at 3.7 per cent year-on-year, verses against a decline of 5.5 per cent.
Remember that investors like unforeseen pleasant surprises — even if they are just, less bad.
Brexit has poured cold water on expectations but, like a rock thrown into a pond, the effects fade with distance from London. Even Europe is unlikely to be much affected unless the divorce is particularly acrimonious, and no side looks ready for a fight.
So policymakers will continue to preside over the slow degradation of money as a means of exchange by printing it, and they will no doubt claim victory over the milky growth that just about underpins our economies and stock markets in the near term.
But by some irony of ironies, a UK in recession at this time should allow British politicians to tighten their belts “in the name of Brexit”, bring in austerity, and give the economy the hair shirt treatment it needs. In the words of President Kennedy, (and George Osborne), they can fix the roof when the sun is shining.
So in a few years, when the money markets finally collapse under the weight of negative interest rates and insecure bond markets, the UK may well rise stronger than most from the ashes of the misguided Brexit vote. The leading indicators will help us sense when that is coming — but you had better be quick, for everybody else will be looking at them too.
Richard Harris is chief executive of Port Shelter Investment Management. www.portshelter.com