Speaker 1 (00:02):
Hello, and welcome to Actively Speaking. I'm your host, Steve b Weiberg. Join us each episode as we discuss current issues concerning capital markets and portfolio management from the perspective of an active manager. Welcome back to another episode of Actively Speaking. Today we're gonna be talking about Brexit, and my guest is Bill Booth. Bill is a portfolio manager here at Epic. He's also a co-chief investment officer, and he's been with the firm for just over 10 years. So welcome Bill.
Speaker 2 (00:32):
Thanks, Steve. Glad to be here.
Speaker 1 (00:34):
Uh, so let's talk about, um, four, I've sort of four topics in mind here for Brexit. Uh, and the first one will be, why has this dragged on so long? It's been three and a half years now, from the time of the referendum in June of 2016. Why hasn't it happened already?
Speaker 2 (00:50):
Well, I think the short answer is it's been a political and legal process that's driven by politicians and lawyers, and not to make light of politicians and lawyers, but I think when they're driving a process, it's inevitably gonna take a long time to play out. So given the nature of the issues, I think it's, it's, uh, naturally gonna take a long time. But beyond that, I think it's an unprecedented event. We haven't had a country try to voluntarily withdraw from the, uh, European Union, certainly if there's been threats of doing so by other countries, but this is really unprecedented in, in, in nature. Uh, and I also think it's dragged out because, uh, most of the players involved are very fearful of a hard Brexit. And so what that's meant is that hard deadlines have never really been hard deadlines. And so we've seen extension after extension in order to avoid what's seen as the most onerous outcome. And then I think the last consideration is, and I always find this surprising, the vote in June, 2016 was 52 to 48%. And you hear the politicians say they have a mandate to get Brexit done. And it's unclear to me that the British population is fully behind, uh, Brexit. And so I think, uh, the fact that you have a 52 40 8% vote, um, has also played into this dragging out.
Speaker 1 (02:10):
Okay. So, um, you mentioned that people wanted to avoid a hard Brexit. And so that leads me to the second question. W at the time that the referendum was approved three and a half years ago, there was a lot of kind of doom and gloom. Uh, people had a very negative view of, of what this was gonna mean. And in the currency markets, it's true that the, the, the British pound dropped quite a bit the next day. But if you look at, uh, what's happened to stock markets in the UK versus continental Europe since then, if you look at them both in local currency terms, have actually done about the same. They're both up actually about nine to 10% annualized over those three and a half years. So there was, uh, this view three and a half years ago, like, oh, this is almost the end of the world.
Speaker 1 (02:55):
Yet again, apart from the currencies, stocks in the UK and on the continent have held up quite well. They've generated good returns, and it's pretty similar in the UK versus the content over three and a half years. Which leads me to the question, why was it viewed as such a bad thing? Because the reality has not been that bad for, certainly for investors and, and for the economies. It, it doesn't seem like the world's ended now, of course. Could be. That's cuz nothing's happened yet. But, but, so that's my question is why was it viewed as such a potentially negative thing?
Speaker 2 (03:27):
I think it's the fear of the unknown. I think, uh, a lot was made to do about, uh, the vote, uh, whether to remain or leave leading up to the vote. And I think the base case assumption by everybody was, of course the UK is going to remain. And so you had a really surprising outcome, uh, that created this, uh, doom and gloom scenario where people are just fearful of the unknown that, well, it's been this way for decades. It has to be bad if the UK decides to, to leave. And certainly, uh, the knee jerk reaction of equity markets was quite negative, both in the UK and in continental Europe on the day of Brexit. Uh, we had stocks down, uh, 30 to 40%, uh, and that was the knee-jerk reaction, uh, by investors. But I think with the passage of time, people, um, have assessed the situation, I think a little more thoughtfully and, uh, under more calm circumstances and have come to conclude that it's probably not going to be, uh, as bad as was was feared and imagined the day of the vote.
Speaker 1 (04:28):
Okay. Well, so the flip side of the question is sort of what evidence is there that, that joining the European Union was a good thing for the UK over the years, and I, I've long had a similarly skeptical view, for example, about the, the benefits of the common currency. Uh, certainly it's more convenient for travelers and so forth, but the idea that, for example, that having a common currency in the e in in the EU would lead to fast economic growth hasn't borne out. I mean growth has, it was, has been slower in the last say in the years since the Euro was created then in the previous, you know, 15 years. So, um, specifically about the UK being part of, of the European Union, what's the pro argument for why they should stay in or why it's a good thing for them to be part of?
Speaker 2 (05:14):
So I think that's a great observation and the pro argument I think boils down to the so-called four freedoms. Um, the freedom of of movement, of, of goods and of people, uh, and of services and of capital, uh, that you have sort of frictionless movement, uh, of these four items and that somehow translates into just better economic prospects. I think the view of probably most of the people who voted to leave the EU is that the only thing that they've seen is the free movement of people. And this is the, the immigration problem that mm-hmm. <affirmative>, uh, many, uh, of the voters who backed leaving, uh, were concerned with that. We had lots of free movement of people. Um, and I think it's less tangible and visible to the average person, have we really benefited from those other freedoms of, of, of moving goods and, and services and capital.
Speaker 2 (06:07):
And I think rightfully, uh, there should be some skepticism cuz I think it's hard to point to, uh, growth rates or other economic, uh, data that would suggest it's been a great thing for the uk or it's been a horrible thing for the uk. Uh, and I think you, you point out something, um, else that's very important, which is, uh, the UK is part of the union but not the Euro zone. And I think that's also ties into your earlier question about why it hasn't been that bad is that the UK has its own currency, has its own, central bank has its own monetary policy. And so really I think at the end of the day what we're talking about is changing the terms of, of trade potentially mm-hmm. <affirmative>, uh, and I think it'd be a much more worrisome situation if we were dealing with somebody like Italy where I just have a hard time getting my mind around, well what if we had to re denominate liabilities from Euros into Lira and just how does that work and, and what's the right exchange rate? Um, so I think, um, given that, uh, the UK has been part of the European Union, but not part of the actual, uh, currency zone, um, is a positive in this situation in terms of being less disruptive.
Speaker 1 (07:15):
Okay. Uh, so after a three and a half years of, uh, kind of delay, um, the UK had another election in December and bars Johnson returned as Prime Minister, but with a larger majority. And it now seems very likely that at the end of January we will initiate the Brexit process. So let's talk about the, my third question. What are the practical implications? What does it actually mean in nuts and bolts terms?
Speaker 2 (07:42):
So, um, maybe just to take a step back, as you, you pointed out the general election, and it is interesting how the whole process has played out in the UK because I would say one of the defining features and probably the, uh, most impactful outcomes of Brexit here to four really has been how much the political landscape has changed. In the UK we've had three, three prime ministers, uh, two general elections, uh, two extensions of, um, the Brexit deadlines. And Boris Johnson did make a big gamble by calling a general election his predecessor, Teresa May did the same thing and it didn't work out quite so well for her. She was trying to consolidate power and in her general election, she actually lost seats in parliament. But, uh, Boris Johnson did have a resounding victory, uh, in December. Uh, the conservative party has a majority that they haven't experienced in, in decades.
Speaker 2 (08:33):
Um, and I'm not so sure that that is changing the 52 48 per se in terms of remain leave. I think it's a, a sign that the British populations just say, let's just be over, let's be done with things already. Like three and a half years is, is way too long. Let's just have some certain outcome. Uh, and so with this mandate, you're right at the end of the January, the UK technically will no longer be, um, a part of the eu, but they will enter a, a transition period, um, that at the moment will last until the end of this year. Uh, and the objective between now and then is to negotiate trade deal, um, which the skepticism is to whether that's actually feasible in such a short period of time, uh, as that process plays out. You know, the one scenario that could, could potentially unfold is that, um, there is no trade deal in the eu and UK will resort to some sort of trading under WTO arrangements.
Speaker 2 (09:29):
Um, but I think that's the, um, most, uh, practical, uh, implication is what does the nature of of trading look like. Um, there's another issue which has to do with, uh, the so-called Irish backstop. Um, this has been probably the single most contentious issue related to Brexit, which is trying to avoid a hard border between Northern Ireland, which remains part of the uk, uh, and the Republic of Ireland, which will be part of the eu. Uh, the solution that Boris Johnson came up with was to put a border in the Irish Sea, which essentially creates potentially a border between, uh, the UK and, and Northern Ireland. So I think that's the other thing to watch out for is, is what does that mean in terms of the, the, the, the trade of goods within, uh, the UK and, and specifically the interactions with Northern Ireland and the Republic of Ireland?
Speaker 1 (10:24):
Uh, okay. So I suppose I'm a French company and I supply goods to a, to a company in England. I'll just take this down to a very practical level. What's gonna change on February 1st, if anything?
Speaker 2 (10:34):
So on February 1st, not much had changed because I think under the terms of the transition agreements, um, most of the existing trade relations, um, will remain intact. I think the more important date is the 1231 date that if there's not an extension of the transition agreement, uh, that the UK and EU would resort to trading on WTO rules. And, and right now sort of in aggregate on goods excluding agricultural products, the average WTO tariff is something like 2.8%. So I guess the good news is, is that in aggregate it doesn't seem to be all that one. Some, especially when you consider what the US has done with China and 15 and 25% tariffs. Um, but there is, uh, the devil's in the details and of course there's a wide range of, of terrorists under WTO rules. And so if you look at the auto sector, for instance, which many people think could be most negatively impacted, you're talking about tariffs that are more in the, the neighborhood of 10%. And then when you get into agriculture, which always seems to be one of the most politically contentious, uh, sectors within the economy, uh, dairy products, for instance, have a 35% tariff under WTO rules. So there could be certain industries that are, are, are very negatively impacted in the short term if there is not a negotiated, uh, new trade deal. But I think in aggregate the situation probably is, is manageable.
Speaker 1 (11:55):
Uh, you, you talked before about, uh, one of the issues being the free movement of people. So that's something that's come up. I know certainly in our industry, well in the financial services industry more broadly, there's been, you've seen reports of, you know, European based banks saying, well, we're not gonna be able to have people based in London anymore. Like, what's, what's behind those stories? What's, why is that?
Speaker 2 (12:15):
So one of the benefits of, of the UK's membership, uh, in the European Union has been, uh, in financial services, something called passporting, which essentially allows for the frictionless import, if you will, of, of services including things like financial services. And that could potentially have a, a very negative impact, uh, as part of the Brexit process. And what we have seen are, uh, many, uh, UK based firms talking about setting up, um, offices, whether in Frankfurt or other parts of continental Europe, to make sure that they're able to, uh, deliver financial services to their clients in those areas in the event that something isn't negotiated mm-hmm. <affirmative>, uh, on that front, uh, in a timely fashion. And so, uh, we have already seen, um, uh, satellite offices and, and relocations, uh mm-hmm <affirmative> occur due to this, this issue with financial services.
Speaker 1 (13:10):
Okay. And that goes in both directions. Is it same that, uh, European firms would they have to open an
Speaker 2 (13:15):
Office? So, so it is bilateral, so, uh, to the extent that there are continental based firms operating and and serving within the uk, they would, you know, face the same challenges. Right. And have to potentially come up with the same solutions.
Speaker 1 (13:29):
Right. Okay. Uh, so fourth and final, uh, topic, let's talk about the investment implications. Uh, what, what does this, you know, what does it mean for investors?
Speaker 2 (13:40):
So I think I would start by saying, uh, we like to say at Epic that we buy companies in our countries, and that's not to, uh, dismiss the importance of a country. We certainly political and regulatory frameworks can matter to a business. Certainly the economic conditions, uh, can matter to, uh, a business. But to your comments earlier about the performance of, uh, the UK market versus, uh, continental Europe, um, there hasn't been a large difference in, in performance. And I think part of this reflects the global nature of many British companies. So if we look at, for instance, the FTSE 100, which is an index that measures the, the largest capitalization companies in, in the uk, it's pretty much done in line with its European counterparts performance-wise over the last three years on a local currency basis. And it's because it has companies that are these large global pharmaceutical companies or consumer staple companies.
Speaker 2 (14:36):
Um, I think from an investing perspective, what I'd be working, looking out for are how sensitive is a business to cross-border trade, uh, between the UK and the eu and how sensitive our businesses to the local UK economy. Because I think, um, that the two issues really are if the terms of trade do resort to WTO rules that, as I said earlier, have very negative impacts on areas like autos. And so one might want to, uh, tread cautiously in areas such as that, um, in the absence of, uh, a negotiated deal. The second piece, your sensitivity to the UK economy there, the question is, could, uh, the UK go into recession as a result of the actual, um, uh, Brexit process practically unfolding? Um, and there my thought is certainly it can go into recession. My own view is if it were, uh, to occur, it'd be short-lived.
Speaker 2 (15:35):
Certainly I think the, the Bank of England, um, is, is standing by ready to offer monetary policy support if it deems necessary. In fact, at the most recent meeting of the Bank of England, uh, a couple weeks back, um, there were two dissenters, um, uh, at the bank who actually wanted to lower rates in, in, in the uk. Uh, and then I think on the fiscal, um, front Boris Johnson was sort of the face of the leave campaign back in 2016 and he was always saying, look, the UK will be better off out of the EU than in the eu. So it's in his vested interest to do everything he can fiscally to support the economy to kind of prove to the people he was right. And I think with this resounding majority that he was able to obtain in this general election last month, that he does have, um, the political support to be able to get some fiscal sim stimulus in support to the economy.
Speaker 2 (16:32):
So I, I guess I'm sangwe on the prospects for the UK economy, uh, and I would be thinking longer term, um, that if for some reason there is a dislocation in the markets and I don't think we'll see another knee jerk down 30, 40% reaction to any potential development, even facing a, uh, a December 31st sort of cliff on, on a new trade deal, if the market were to present any sort of a selloff on fears related to Brexit, I think that very likely could be an opportunity for investors to, to, to buy high quality companies at a discounted price. Cuz I think ultimately the UK is gonna be just fine outside the eu.
Speaker 1 (17:13):
Um, you know, it's, uh, it's kind of funny, if you think back before Brexit passed three and a half years ago, there was the talk in the previous years had been dominated by issues like, you know, why Europe have such structurally slow growth and the need for reform in various parts of the economy. And then Brexit came along and has just dominated the discussion after three and a half years. And a lot of those other issues have been kind of ignored, assuming we go forward now and Brexit happens and it's behind us and whatever happens happens. But the point is it's not really a subject for discussion and debate anymore. You know, it's like it's over. Uh, we're just dealing with the aftermath. What do you think people are gonna talk about <laugh> in Europe and the uk? Uh, are we gonna go back to, are some of those old issues gonna resurface again about, uh, you know, the structural slow growth in in Europe?
Speaker 2 (18:01):
Yeah, I think, I certainly think the the attention will go back to those structural issues and I think, um, they haven't gone away. And I think the evidence of that is the weakening of Angelo Merkel's, uh, power in Germany, the rise of sort of, uh, more extreme political groups in, in many countries. Uh, you've seen the, the, the protests over the summer last summer in France. So I don't think any of the structural issues have been resolved. I think they've just kind of been brushed aside a little bit to, to focus on, on Brexit. And you know, I think at the end of the day the, the issue remains that the eu, uh, it's a monetary union but not a fiscal union. And until that fiscal issue is addressed, it's hard to see, um, the type of reform that really could sort of take potential GDP growth in the next level.
Speaker 2 (18:51):
And so, um, I think people will be watching to see how does the UK bode, uh, in its first years outside of the European Union. And of course, um, during this whole process, there's also been the talk of moral hazard that if the UK kind of leaves and everything seems to be okay or even better, then does that all of a sudden cause Italians to say, you know what, let's, let's revisit, um, potentially leaving the European Union. As I said earlier, I think countries are part of the monetary union leaving and certainly any country of size within the monetary union leaving that I think would be a much more problematic situation for the politicians to deal with as well as markets to get their arms around.
Speaker 1 (19:32):
Right. Okay. Well Bill, thanks very much for joining us. And you know, we'll, we'll have to reconvene at some point down the road, see how this has all turned out. Uh, until then, uh, thanks for joining us everybody, and we'll talk to you again soon. Remember to subscribe to actively speaking on Apple Podcast, Spotify or Google Play. You can find all of our previous episodes and additional content on our website, www.eipny.com.
Speaker 3 (20:00):
The information contained in this podcast is distributed for informational purposes only and should not be considered investment advice or recommendation of any particular security strategy or investment. Product. Information contained herein has been obtained from sources believed to be reliable but not guaranteed. The information contained in this podcast is accurate as of the date submitted, but is subject to change any performance information. Reference in this podcast represents past performance and is not indicative of future returns. Any projections, targets, or estimates in this podcast are forward-looking statements and are based on epic's research, analysis and assumptions made by Epic. There can be no assurances that such projections, targets or estimates will occur and the actual results may materially be different. Other events which were not taken into account in formulating such projections, targets or estimates may occur and may significantly affect the returns or performance of any accounts and or funds managed by Epic. To the extent this podcast contains information about specific companies or securities, including whether they are profitable or not, they are being provided as a means of illustrating our investment thesis. Past references to specific companies or securities are not a complete list of securities selected for clients and not all securities selected for clients in the past year were profitable.
Speaker 4 (21:28):
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