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Early Investment Implications of the Brexit Brouhaha

Neil Dwane | 12/08/2016
Early Investment Implications of the Brexit Brouhaha

Summary

Now that the initial volatility has passed, the UK is in a better post-Brexit position than Europe – at least for now, says our global strategist. But an overall feeling of uncertainty will make the hunt for income a key theme for the rest of 2016.

Key takeaways
  • Global uncertainty, which was already high given ongoing financial repression, grew worse following major geopolitical events in France, Turkey and beyond.
  • The UK’s economy is facing big headwinds, but it should benefit from more BOE stimulus, more fiscal spending and a weaker currency.
  • Political uncertainty abounds in Europe, which is already very sensitive to the dull global growth environment.
  • A global flight to safety has boosted bonds at the expense of equities, which now seem “cheap for a reason” in the UK and Europe.
  • Asia has been less affected by Brexit; positive trends are developing in China, India and Japan. Meanwhile, the US has become the world’s default “safe haven”.

Global markets have been regaining some much-needed poise in recent weeks as the volatility of the unexpected Brexit decision has begun to subside, with regions around the world responding to their own particular rhythms while singing a similar overall tune. At the same time, global economic uncertainty – which, in keeping with our financial repression theme, was already high – has been exacerbated by a range of factors beyond Brexit, including terror attacks in Europe and an attempted coup in Turkey.

It would therefore seem prudent to expect more political uncertainty on the horizon, especially given Europe’s upcoming referendums and November’s US elections. Factor in this uncertainty with dull economic growth globally, and it becomes clear why investor attention is shifting toward the stability that income generation can provide. This “hunt for income” is a long-term trend that should primarily benefit assets in the US and Asia for the rest of the year.

The hunt for income is a long-term trend that should primarily benefit assets in the US and Asia

Europe and the UK

As we expected, Brexit has been affecting Europe more than the UK, which is regaining its balance as it puts a new government in place. Britain’s new leaders have a clear mandate to leave Europe as smoothly as possible while, for the first time in 40 years, engaging more constructively with the rest of the world. With the pound sterling moving lower in a post-Brexit world, the UK’s economy will face headwinds, yet it should also benefit from additional proactive monetary stimulus measures and investments from the central government. Sterling’s downward trend has given solace to UK-based international corporations, which has helped the UK outperform Europe so far.

Europe, meanwhile, faces a period of political uncertainty as Brexit takes its toll, but the region should be less affected economically by any serious consequences even as it remains very sensitive to the dull global growth environment.

Both markets have experienced a flight to safety as investors reallocated toward sovereign bonds, which were already moving higher in Europe thanks to the European Central Bank’s policies. This boost for bonds comes at the expense of equities, with financial companies in particular hurt by the uncertainties that Brexit has created for regulation, “passporting” and economic growth. Overall, it appears that equities in the UK and Europe look undervalued in a global context, but they are also now “cheap for a reason”. This environment may last for a few years, unless or until negative interest rates force Europe’s cash and bond holders to seek higher equity yields.

Equities in the UK and Europe look undervalued, but they are also now “cheap for a reason”

Asia Pacific

Now that the initial shock has subsided, Asia has been generally unaffected by Brexit; instead, more significant local situations have been developing:

  • China continues to stabilize as it enacts its next five-year plan.
  • Prime Minister Modi of India is continuing to make positive legislative progress; he is also recovering from the impacts of a poor start to the monsoon season and the loss of the Reserve Bank of India’s governor.
  • Japan has re-elected Prime Minister Abe, who now seems ready to move to “Abenomics 2.0”, although it is unclear if this shift will include actual structural reforms rather than just more QQE from the Bank of Japan and more fiscal stimulus from the government.

With Europe clouded by uncertainty, Asia and emerging markets offer a combination of alluring factors

At the same time, Asia remains very sensitive to the strength of the US dollar and to global trade activity, which remains in the doldrums. With Europe still clouded by uncertainty, Asia and emerging markets now offer a combination of alluring factors:

  • For equity investors, Asia has undervalued markets that also provide the potential for some earnings growth.
  • For investors who feel unwilling or unable to take equity risk, Asia offers high-yielding local and hard-currency sovereign bond investments.
US

The US has become the post-Brexit world’s default “safe haven”, with the US dollar getting stronger and global buyers of US Treasuries driving yields lower. Hard-currency high-yield bonds are still attractive and, despite the United States’ dull but solid economic progress, the US Federal Reserve still wants to move US interest rates higher. As a result, while US equity valuations are stretched and earnings expectations are still muted, the US has become the safest place to take a moderate amount of risk in exchange for modest return potential.

Of course, political risks are clearly rising in the US, and that will add to the overall market volatility that we anticipate will peak in November. Nevertheless, when compared with ongoing difficulties in Europe, the challenges the US is facing may begin to seem increasingly manageable to a growing number of investors.


Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.
This material is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

Expert-Image

Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.

Globalization in Remission: Has the Political Trend Changed?

Neil Dwane | 27/09/2016
Globalization in Remission

Summary

Our global strategist says we could be at the tipping point of a shift away from globalization and deregulation toward populism and protectionism, which could have important implications for investors.

Key takeaways
  • The two primary forces driving politics today are the rising power of emerging markets and the growing inequality of wealth.
  • These forces once went hand in hand with globalization and deregulation, which are fading and could be further unwound by a new breed of populist politicians.
  • In this environment, large multinational corporations may hold less sway over policy and taxation issues, which could help mid- and small-size regional companies.
  • Politics could become more local, with politicians demanding more regional investment, taxation and representation.

Politics has always been part of the narrative of investing, and just underneath the surface lies an ebb and flow of influences that can direct politicians and their policies. At our recent Investment Forum in Frankfurt, we considered some of the many factors that are keeping politics at the top of investors’ minds today – like the Brexit decision in June, the US presidential election in November and Italy’s upcoming referendum. As we took a closer look, we found that these events may not be part of the usual tide of relatively unrelated political occurrences; rather, they seem to be connected by a longer-running and deeper momentum.

Consider that from 1980 through to the Global Financial Crisis (GFC), the world witnessed a clear political trend toward globalization, deregulation and closer international cooperation. This trend benefitted consumers globally as traded goods prices fell – albeit at the cost of hollowing out many domestic manufacturing industries – and it helped big multinational companies that could capitalize upon and optimize their selling prices and logistics.

The “winners” of globalization were mostly multinational corporations and mercantilist economies and companies in Asia, particularly in China, where wages were low and the ease of competition and technology transfer high. The “losers”, on the other hand, were the lower- and middle-class workers and domestically oriented businesses in the developed world that could not match these imported prices. For decades, governments competed to attract multinational companies and their investment power, even though they contributed little save for employment and offered local economies only a small amount of value added. This dynamic helped fuel the debt-funded global consumption boom as trade surpluses were recycled back, and it contributed to the growing wealth effect for those not hurt by globalization – a phenomenon that has accelerated with the integration of the internet and mobile telephony that now rests in consumers’ hands.

A political tipping point

Today, however, there is much evidence that we are seeing globalization slow if not reverse, leading us to believe the world may be at a political tipping point:

  • The Brexit vote and themes raised in the US presidential race suggest that many voters in the developed world feel the markets no longer work for them, and that the benefits of globalization have been offset by its weaker wage and employment prospects.
  • Multinational companies appear to have been gaming the global tax system, with the result that they have no obligation to pay taxes on goods and services as they play one government off against another.
  • The weak, dull economic growth seen since the GFC has not created wealth and welfare for many parts of society – and government bureaucracy and outdated labour legislation have made matters worse.
  • A growing number of millennials – those born after 1985 – are already burdened by high education loans and poor job prospects, and they are becoming increasingly disenfranchised by democracies that concentrate on satisfying their Baby Boomer parents – creating a source of inter-generational tension.
  • The “haves” and “have-nots” have always been part of human history, but today’s rising levels of economic and forced immigration have denied wage increases to local workforces and lowered living standards. This has added to a growing sense of wealth and income inequality, fuelling nationalist fears and populist politics.

De-globalization’s implications for investors

While much remains uncertain in the realm of politics, it is now clear that the former trends of globalization and deregulation have slowed or are in danger of being reversed. Once any trend like this has started, it could last for some time, if history is any guide. Consider that the last prolonged period of globalization culminated in the Great Depression in the 1930s and the Smoot-Hawley trade tariffs in the US, which did not get redressed until the early 1980s by President Ronald Reagan. Of course, while it may be too soon to say what the exact effects of this political trend will be for investors, we have identified a few early implications:

Less global trade means less global growth

Politicians are rowing back on several major global trade agreements currently under discussion, such as the Trans- Pacific Partnership and the Transatlantic Trade and Investment Partnership, which will inevitably add grit to the global gears. With global trade constituting approximately 40 per cent of global gross domestic product, this could slow economic growth at a time when it is already fragile. If global trade were an economy, it would be the largest in the world – nearly twice the size of the US economy – but it is rarely viewed in this way by policymakers.

Corporate responsibility must be redefined

Many multinational corporations have benefitted from decades of globalization, especially in terms of trade and finance, but this could eventually become a headwind if politics increasingly favours local brands and forces local taxation. More immediately, the recent Apple/European Commission tax rulings could increase inter-regional tax friction, which could hinder the allocation of capital and reduce returns to shareholders. The world does not need more friction; remember how protectionism became a key theme in the 1930s, when the world tried to stabilize after a previous period of globalization. For our part, we at AllianzGI are committed to engaging with management teams and governments to ensure that corporate responsibility is viewed in the widest manner possible – beyond just earnings per share or tax revenues.

Fiscal spending should be fiscally responsible

Dull levels of economic growth may be met with growing calls – such as those heard this past summer – for more fiscal and infrastructure spending, though there should be mounting concern over the affordability of such outlays. Enormous investments are certainly needed in the big economies of the future such as India, Indonesia and Africa, not to mention the repair and maintenance needed in the developed world. Yet rather than be funded by more borrowed money, these investments must both cover the cost of financing and add to these regions’ economic prosperity and productivity. If not, they are simply Ponzi schemes.

Keeping promises is expensive

Soon, politicians in the developed world will have to confront the cost and financing of their welfare states, or risk seeing their millennial children revolt against honouring the unfunded promises made to their parents. These structural reforms are currently eluding demographically challenged areas such as Japan and much of Europe, and the longer these challenges are left unanswered, the bigger they will become. Indeed, even in the US, the current outstanding debt-to-GDP level of 100 per cent is dwarfed by the promises on the books that are yet to be accounted for – entitlements that add up to more than 500 per cent of US GDP, or USD 130 trillion.

The Western world view may be fading

Immigration and the recent rise of radical Islam across Europe and Central Asia will create more political tension in the foreseeable future – tension that may sustain higher levels of populism and nationalism than any we have experienced since World War II. The secular Western perspective of the modern world, under Pax Americana, is ending and being replaced by a return to an older-world version of countries and states that predates the WWII-era solutions imposed by the US and the UK. This revision is also taking place in a region full of oil and replete with many long-standing histories and frictions – another example of today’s political trends connecting in a new way with the politics of the past.


Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.
This material is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

Expert-Image

Neil Dwane

linkedIn
Global Strategist
Neil Dwane is a portfolio manager and the Global Strategist with Allianz Global Investors, which he joined in 2001. He coordinates and chairs the Global Policy Committee, which formulates the firm’s house view, leads the firm’s bi-annual Investment Forums and communicates the firm’s investment outlook through articles and press appearances. Neil is a member of AllianzGI’s Equity Investment Management Group. He previously worked at JP Morgan Investment Management as a UK and European specialist portfolio manager; at Fleming Investment Management; and at Kleinwort Benson Investment Management as an analyst and a fund manager. He has a B.A. in classics from Durham University and is a member of the Institute of Chartered Accountants.
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