The Weekly: Could the UK re-join the EU?

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10/09/2018
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Given the close result of the EU referendum there was always going to be calls for a second vote. Theresa May has thus far rejected any rerun, citing that a second referendum would be a gross betrayal of our democracy and trust. Before the referendum took place, both sides agreed that whatever the result, that result would be final.  Britain will leave the EU on the 29th March 2019.

The only question that remains is what Brexit is going to look like.  Theresa May has one vision and the EU has another. Meanwhile, Boris Johnson dislikes both. The latter’s hopes of the top job seem to be diminishing by the day. His weekend references to Britain putting on a suicide vest and giving the EU the detonator crossed a line for many Conservative MPs.

There is no doubt that Boris Johnson prides himself on being a great orator, and one quote of his does seem to be particularly relevant at the moment:
‘My friends, as I have discovered myself, there are no disasters, only opportunities.  And indeed, opportunities for fresh disasters.’ All very Churchillian but highly aspirational.

We think everyone can agree with him on that point, he does seem to lurch from one self-inflicted disaster to another. If it isn’t his comments made in his Sunday column, it is his private life stealing the front pages. It is for this reason that we think the chances of Boris Johnson becoming the next Prime Minister are slim. Having said that, this does not mean Theresa May will be able to get her Chequers plan through Parliament.

Within most offices up and down the UK, opinions on the benefits and disadvantages of withdrawing from the EU are discouraged in the pursuit of a tranquil environment. However, opinions are not fact, and the true benefits/disadvantages will not be known until we leave, most likely not until many years later. If the disadvantages outweigh the benefits then perhaps we haven’t heard the last of Brexit and we could face another vote on perhaps re-joining the EU in ten years’ time.

If this is the case, then there are two questions that we believe need answering.  Would the EU have us back? And secondly, would the UK meet the requirements for joining the EU? Given the increasingly acrimonious divorce, there is a fair chance that the EU may not want to take us back. However, should they agree, then it is unlikely that our membership would look anything like that which we currently have. For example, we may be forced to adopt the Euro, and any rebate that is currently enjoyed would be consigned to the history books. After all, if we are looking to re-join the EU it would in all likelihood be from a position of weakness.
  
The Maastricht criteria dictate the economic conditions for joining the EU. One potential stumbling block is the requirement that the ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Currently our debt stands at £1.78 trillion, or 86.58% of GDP. To put it another way, evenly split amongst the 65 million people living in the UK, it stands at over £27,000 per person. This figure is even higher if the debt is only distributed amongst taxpayers.

We may find that this debt gets even higher, especially if Labour is successful in the next election. Their plans to privatise everything from railways to Royal Mail will only increase our percentage debt to GDP. However, should economic turmoil ensue after Brexit, then we would expect it to grow under any government as they try and spend their way to a stronger economy.

That is not to say the EU will be a Union we want to re-join several years down the line. Several EU economies are looking increasingly precarious and given that a nationalist far right party has managed to demonstrably increase its share of the vote in Sweden, some would say that across Europe, people are becoming more discontented with EU membership.

Within corporate news, it would appear that the conglomerate is back. We know that diversification is the cornerstone of any investment portfolio; however, it seems that companies themselves are taking it upon themselves to diversify. Coca-Cola’s takeover of Costa last week is one such example. Many will point out that both operate within the beverage industry which is correct, but in fact it can be argued that Costa actually operates within the retail sector. Are Coca-Cola retail experts, and what exactly are they getting for their money? A large international presence which will allow them to compete with Starbucks? We think not. Costa is very UK centric, and what works in the UK does not necessarily work abroad. Grow Costa within the UK? Again, we don’t think so.  In fact, it can be argued that the UK is at ‘peak’ coffee. Often there are two or three Costas on every high-street. Their vending machines adorn every petrol station, supermarket and airport up and down the country and they already sell Coca-Cola.

Diversification is always a smart move for any investor, but we are more sceptical of companies performing their own diversification. In our opinion they should stick to what they are good at. Of course, Coca-Cola is a huge multinational company and the £4.9 billion it is paying Whitbread for Costa is not a stretch for them. There is no doubt Coca-Cola is worried about the current health trends, as well as government crackdowns like the sugar tax that has recently been introduced. So a knee-jerk reaction has been to diversify outside their traditional marketplace.

However, this pales in significance to the crackdowns that big tobacco have faced over the decades, and we didn’t see these companies diversify. Some would argue that tobacco is a more addictive product so it’s not comparing like for like, however some believe sugar is just as addictive. Apparently, everyone’s favourite investor, Warren Buffet, drinks at least five cans of Coke every day.

Coca-Cola should take a look at a company that tried to diversify into its own marketplace. Richard Branson attempted to enter the cola market in 1994 with the launch of Virgin Cola. Despite being priced lower than both Coca-Cola and Pepsi it never managed to gain significant traction or customers. The brand struggled and only obtained a 0.5% market share in the US and it never made a profit, eventually succumbing to its wounds in 2012 and entering administration. In a completely different marketplace with significantly more competitors, Coca-Cola could well find themselves in the same position as Virgin Cola. Stick with what you know you are good at, selling sugary water, rather than taking a UK centric coffee-shop brand and launching it into a mature and saturated US marketplace.

Global equities retreat on EM worries

Most major equity markets suffered last week amid ongoing emerging market concerns. The UK’s FTSE 100 index closed the week -2.1% lower.

The MSCI Emerging Markets index has fallen -14.0% over the last six months. Difficulties in Argentina and Turkey recently have been followed by South Africa falling into a technical recession and Indonesian currency concerns. Emerging markets have been fighting a difficult combination of a strong US Dollar and rising trade tensions. As yet, US President Trump has not confirmed the additional duties on a proposed $200bn of imports from China and media reports indicate that it may be several weeks before they are put in place.

US market losses were moderated by strong economic data. The S&P 500 index returned a weekly fall of just -1.0%. US manufacturing and non-manufacturing purchasing managers' indices (PMI) both jumped in August, suggesting business activity levels remain strong across both areas. Friday saw the release of the latest US Labour Report:  Nonfarm payrolls rose 201,000, a little ahead of forecasts, while the unemployment rate remained at just 3.9%. The 10-year US Treasury yield climbed eight basis points to 2.94% as the report revealed an uptick in wages to its fastest rate since May 2009. Wage growth has been notably lacking in recent years in what would appear to be an otherwise tight labour market.  

Elsewhere, European equity markets suffered losses last week like most; Germany’s DAX 30 falling -3.3% whilst the French CAC 40 slipped -2.9%. Meanwhile Japan’s Nikkei 225 succumbed to a -2.4% decline. 

The currency markets saw Sterling rise +0.4% against the US Dollar last week but closed flat against the Euro. There have been few clear signs of progress towards a Brexit agreement between the UK and EU, with more lenient rhetoric and willingness to negotiate in recent weeks from both sides. Sterling has enjoyed a modest appreciation in recent weeks which typically acts as a headwind for the FTSE 100 given its bias to overseas revenue.  

Week ahead

This week is another busy one for major data releases and central bank activity. Domestically, the ONS released its monthly GDP figure this morning which revealed a steady +0.3% expansion during July, boosted by the warm weather and the World Cup. On Thursday, the Bank of England hosts its latest monetary policy committee meeting, although no changes are expected on this occasion. In the US, key items to keep an eye on include CPI inflation and retail sales. The Federal Reserve also releases its latest economic update in the form of the ‘Beige Book’ on Wednesday. Eurozone focus will on the ECB as it holds its own monthly meeting with interest rates set to be maintained at 0.0%. Asian activity is particularly profound with a third revision of GDP being the standout in Japan, alongside industrial production for August. The latest industrial production number is also due in China with other notable data including the likes of inflation, unemployment and retail sales.