Looking at the Brexit issue, analysts at Kepler Cheuvreux think it is not just “a fiasco for consensus thinking,” but also a statement on the entire investment year where oddity has been the watch word. The vote that the mainstream thought would never happen happened — and the consensus of analyst opinion, the sheep point of view, all got it wrong. But more than just Brexit, the report notes a market environment change all should be aware of.
While consensus was wrong on Brexit, treat it as a one off and look at the larger trends
“The two months that have elapsed since Brexit day allow us to clarify the nature of its fallout in financial markets,” Christopher Potts, head of economics and strategy research at Kepler Cheurvreux wrote. “The repercussions have not conformed to the expectations of the investment consensus, but then this entire investment year represents a fiasco for consensus thinking.”
It is here Potts points to a more meaningful message. Brexit is really a blip on the radar screen. A more meaningful trend is in place and it is a continuation of the January / February 2016 sell-off and market rebound.
“From the perspective of global equity values the UK’s referendum of June 23rd marked a brief interruption of a rising trend that emerged from the turmoil of January-February,” Potts wrote. “The consensus doubted that the trend was rising prior to the vote. It claimed that a ‘Leave’ vote would be damaging for risk assets, even beyond Europe. It has been wrong on both counts.”
Potts does acknowledge that economic damage has been done by the vote, “represented by the under-performance of the region’s domestically-dependent assets since June 23rd,” with financials overwhelmingly taking the brunt of negative market reactions.
Potts: Dependence on monetary policy is ending, are you ready?
What Potts doesn’t mention is there are alternative investment managers who actually track consensus viewpoints to develop counter-trend thesis depending on certain factors. It is unclear if CBIC did this when they laid down their benchmark thesis that said UK assets would bounce in value after the Brexit, but they were not the only analysts who broke with the herd of sheep on the issue.
Move past Brexit and see the bigger issue, is part of the message in the August 22 “Madmen in Authority” report.
The significant trend to track is that “the long period of over-reliance upon hyperactive monetary policy in the developed world is coming to an end.”
This is a big statement, but one that is generally discussed in public, most often in hushed terms. The realization is being made that monetary policy is near the end of its rope and fiscal policy — building roads, bridges and infastructure as opposed to purchasing financial assets — may be required in the future.
Look to commodities, emerging markets and easing of bank regulations
Despite long term financial damage done by the vote, Potts says it is both emerging markets and commodities should be more on the radar than Brexit.
“It has become apparent that the increase in the perception of investment risk attached to European assets has accelerated the decline in the perception of risk associated with emerging markets,” he wrote. “The surge of retail buying of EM funds in recent weeks indicates that these markets are back in fashion.”
Potts is “surprised” that analysts think “reaching for yield” provides explanation for interest in the emerging-commodity space. There are bigger issues at play:
The reflation in the global US$ zone originates in the effects of a stable US$ and lower real interest rates. The end of the US$-commodity shock translates as a recovery of both nominal and real growth in the emerging world.
The identification of the sources of the resurgence of the commodity-emerging space explains the barrier to a new multi-year bull market in these assets: the Fed has not abandoned its monetary agenda.
What this means is potentially a bullish outlook for European shares:
Thanks to the benign international environment we consider that the recovery of European equity should be able to extend, despite the characteristic weakness of capital flows into the region. The continued improvement in credit conditions throughout the region, including for the banks, is especially helpful. We see no reason to change our interpretation that major European equity benchmarks can eventually break through the area of strong resistance that is currently holding them back before the end of this quarter.
But what is really going on in Europe among the hallowed halls at the European Central Bank may be what helps the banks the most. If the banks can prosper, the regional economy will flourish, has always been the establishment mantra. In this regards, Potts does not disappoint:
…the necessary condition for the reversal of the acute international under-performance of European equity should be clear: the domestic cyclical universe must show more resilience. In this respect we cannot count upon much further assistance from the ECB, at least as regards interest rates and asset purchases. Alternative avenues of assistance are being explored for Europe’s financials, notably the reduction of regulatory restrictions upon the banks.
In a world where banks have been essentially let loose from accountability, less bank regulation is the answer.