When considering the investment risks that would arise from the implementation of an anti-capitalist
Despite the way in which the Brexit negotiations have been conducted to date and the public fissures within the Conservative Party, it seems remarkable that Her Majesty’s Loyal Opposition is not a considerable distance ahead in the opinion polls. Perhaps this is due both to the lack of clarity and candour relating to the Opposition’s own position, and the limited enthusiasm within the PLP for a leader foisted on the party by their membership. We cannot be certain that either leader will remain in situ until the next election, but Mr Corbyn seems much the more likely of the two to last the course. Given his outperformance versus low expectations in 2017, particularly with younger voters, one cannot have any confidence that current stated voting intentions will be sustained. The Guardian columnist Polly Toynbee also points out that many Tory voters will have expired before the next election while children aged twelve in 2016 will be able to vote in 2022.
Now let us return briefly to Brexit, and we must first rule out the least likely outcomes. Despite the current strategy of brinkmanship on both sides of the negotiation, Brexit now seems increasingly unlikely. By ‘Brexit’ I mean the Brexit that David Cameron told Leave voters that they would be choosing on the 23rd June 2016. This is what is now referred to as a ‘hard Brexit’, ‘cliff edge’ or ‘crash out’ Brexit. I would not take issue with the final two descriptions given that the departure from the Single Market and Customs Union would have required preparation of at least the two years following the triggering of Article 50, not the 46 days remaining until the 29th March deadline. However, the chances of a second referendum leading to no Brexit also appear to be receding. Neither of the main party leaders appears to favour this outcome and dare not either offend their Brexit voting colleagues and constituents, or risk further damaging delay and uncertainty that has already caused the economy to stall. So, a ‘soft’ Brexit it is – either a close relative of Mrs May’s deal or some form of customs union. We can therefore rule out both the Bank of England’s worst short term economic predictions and the levels of anarchy in the House that would lead to an election before the Conservative’s fixed term expires in 2022. Again, perhaps brave assumptions, but ones with which I’m becoming increasingly comfortable.
If the more moderate wing of the PLP avoids either de-selection or the temptation to form a new centre-left party, then Mr McDonell’s radical manifesto might be watered down. Moreover, a labour government with a working majority of a size that could implement the most radical of their policies would require an electoral swing of historic proportions. But let us assume that UK political opinion swings sufficiently away from free market capitalism to allow for the radical change that would result from the election of Mr Corbyn’s Labour Party with a working majority. Unless the reader sees this as a zero probability, he or she must conclude that it would be foolhardy not to develop strategies to cope with the economic and investment risks that would result.
A manifesto that includes commitments to nationalise utility companies, the railways and public/private infrastructure partnerships and the sequestration of 10% of every UK company’s equity for worker ownership, is an indication of a more general desire to suspend the workings of the free market and to rebalance the economy in favour of the labour-force at the expense of capital. This would inevitably lead to a flight of capital from the UK and a sharp fall in the Pound’s value. Dramatic increases in Government spending commitments would put further pressure on both the currency and domestic interest rates in the expectation of increased government borrowing. And be aware that unlike Mr Hammond, Mr Mcdonell would not have the luxury of financing his deficits at a cost of under 1.2% p.a. for ten-year money. It is therefore not a huge stretch of the imagination to fear that a very significant Sterling risk premium will cause both long and short-term interest rates to rise, maybe to high single digit percentages. Remember that Greece suffered similar treatment – and they were in the Euro and therefore effectively underwritten by Germany and the other members of the Eurozone.
The most obvious investments that would provide protection from such an outcome will be assets that are denominated in hard currencies and have earnings with limited exposure to the UK economy. Many UK FTSE 100 companies provide such a profile but could have valuations temporarily contaminated by their UK domicile – even though Shell and HSBC, which alone account for over 17% of the FTSE 100 Index, earn and pay their dividends in American Dollars.
If there remain safe havens away from central government interference that offer exposure to UK infrastructure spending, there is no doubt that this could prove a sweet spot within the UK’s economy, as the indications are that additional funding would be poured into sectors such as housebuilding and transport infrastructure. Conversely, interest rate sensitive assets such as long dated bonds and both residential and commercial property would see yields rise, values decline and in the latter case, rents and occupancy come under downward pressure. Index linked Gilts will provide some protection against the inflationary effects of high government spending and rising deficits and of course there is gold, the perennial US Dollar denominated funk-hole for frightened investors.
Should investors also consider the diversification benefits provided by the Euro and Continental European markets? Probably not. Apart from the inevitable contagion from the economic fallout in the UK which currently imports a net £67 billion* of goods from the EU, the Eurozone also faces issues almost as economically and politically fearsome as a Corbyn government. And so it is US Dollar-related investments which would include the Far East and Emerging Markets, that could offer better immediate protection from falls in the value of Sterling assets. However over the longer term, those of us who wish to remain invested in the UK and to generate reliable returns denominated in Sterling, must locate assets that can provide both sustainable income and protection against the effects of inflation. *Full Fact 28th August 2018
If we accept lessons from the 1970’s we must focus our investments in ‘real’ assets (as opposed to cash and fixed income securities, ‘monetary’ assets) such as property, but only when valuations have moved to more sustainable levels; companies exposed to growth industries with diverse sources of income; green technologies that will remain in favour under a Labour administration and, as yields rise to reflect the risks, UK Gilts when they provide such rich yield premiums as to become irresistible to those who believe that the socialist experiment will be relatively short lived. The latter requires confidence that the younger voters with no previous experience or knowledge of three day weeks, power cuts, militant unions, hyper-inflation and mass unemployment, quickly learn these lessons of the 1970’s and allow the country to change course and again enjoy a prolonged recovery with the disinflation and high growth that in the 1980’s led to long and sustained bull markets in equities, property and bonds.
Last but certainly not least, residential property, the asset that underpinned so much of the wealth created during and immediately after the last extended period of high inflation, would enjoy a long-awaited comeback. If we have learned nothing else from the experience, during periods of high inflation, a borrower not a lender be. In 2017, average full time workers could expect to pay around 7.8 times their median gross annual earnings on purchasing a home in England and Wales. The figure for newly built homes was 9.7 times. The equivalent figures ten years earlier in 1997 were 3.4 times and 4.6 times respectively. These figures taken from the Office for National Statistics show the scale of the decrease in the affordability of homes in England and Wales.
The high interest rates and rising unemployment that we could expect following a period of increased government borrowing and rising interest rates would provide the catalysts required for a return to affordability ratios of three to four times average earnings, which in turn would enable the next generation to buy their own homes and allow inflation to erode the value of their debt while their homes rise in value. Margaret Thatcher’s ‘Home-owning Democracy’ would be reborn – an ironic outcome from a period of inevitably unsuccessful anti-capitalist economic policies. Perhaps the young are not so ill-advised voting to re-learn these lessons from the past after all – the result might just enable them to afford their own homes and inflate their way out of debt, just as their grandparents managed so successfully in the 1980’s. That is of course if they haven’t already fled the country in search of gainful employment and more moderate taxation.
