As a ‘leave’ supporter I calculated that Brexit in the short term the UK would suffer political, economic and business turbulence. This is very clearly seen today, from resuming Prime Ministers, ministerial revolts, investment fund contractions, a crashing pound and stock market. But in the medium term I am excited at the opportunity afforded to the UK. This is predicated on the idea that rational heads will prevail and reasonable actions and negotiations will emerge to supper mutual gain. As such there are a few key metrics to watch, that will signal when the market percieves that opportunity is on the cards.
The key metrics to watch are:
- FTSE 250: This key metrics fell just under 15% post vote, recovering so far but still down about 9% down. The FTSE 100 is not useful in this regard as it is not representative of the U.K. business population at large. I would expect the FTSE 250 metric to take 6-12 months to stabilize, then 12-24 months to recover losses and head into positive territory. Interestingly if you agree with my premise there will be some great “buys” in the FTSE.
- Sterling/Dollar: more volatile than the stock market, the pound dropped to several new 30-year lows against the dollar. This is more interesting and important than the stock market for multiple reasons. First, the drivers of the other currencies are less grounded in knock-on results of Brexit and more grounded in local economic and political uncertainty. The dollar is a very safe haven, and the U.K. was too, until Brexit, compared to (say) the Euro. Sterling is floating around $1.28 at present and may yet fall further. I would assume a depressing effect on the exchange rate for 6 months. After that it will be flat and slowly recover losses through the next 6 months. A year from now it will be close to Brexit levels and even stronger. And don’t forget: at present, with a declining pound and the UK still part of the EU, the country’s trade is operating as if with a competitive devaluation. Exports will see higher demand and imports will be more expensive, thus improving the balance of payments. No wonder there is no rush to initiate Article 50.
- U.K. 10 year gilts (bond) yield. This is where things get interesting. If market confidence in the UKs long term stability falls, the price on its 10 year gilts should fall and its yield rise. When confidence increase, as seen in the US and German 10-year bonds, process rise and yields fall. The odd thing is that UK 10 year gilt yield dropped post Brexit and remain well depressed. It is as if the long term market confidence in the UK economic position remains strong. It is also partly a reflection in the market’s belief that the Bank of England may need to lower interest rates (or even increase QE) in order to head off any potential economic contraction.
And for a long term metric to watch:
- UK company start-ups rate: this less-sexy and less-reported statistic is running at historically high rates and in excess of many other advanced economics. This is a great long term metric to monitor since it should support the idea of creative destruction in that resources are automatically reassigned to more productive use via (free) market operations. Second, the fact that the metric is rising is also a reflection of the proportionately lower levels of red tape in place in the UK, even compared to other economies. For example in the US such red tape has increased, and the US company start-up rate is at historically low levels.
The reality though is that all bets are off should negotiations for Brexit turn ugly. Rational responses to negotiation are required, all round. If the EU seeks to cut off its nose to spit its’ face, everyone will lose even more than we have seen so far, and more so in the Euro.
For all the data I would keep my eye on the 10 year gilt yield. The U.K.’s fiscal and monetary policy will be managed closely to help preserve economic stability. Negotiation re Brexit, and especially trade deals, will be keenly watched. Confidence in sterling vis-a-vis the dollar, yen, yuan and euro is critical. So the minor changes in the gilt yield will represent a single KPI representing market confidence in the UK.