UK voters have chosen to leave the EU. I make no claim to be any more enlightened than the crowds as to what sort of political relationship the country will end up having with its neighbours. Instead, we shall keep focused on two vital areas for the fund we run: the European economy and the political response from mainstream politicians across the region.
It is a truism that uncertainty is bad; not just for markets but for economies too. Why would a company make a major capital expenditure decision if the economic outlook was less clear than usual? Similarly, hiring decisions are likely to be deferred. Consumers might feel less job-secure, and so curb spending. These uncertainties will be felt most acutely in the UK, but will ripple out across the continent. The experience, two summers ago, of how EU sanctions against Russia slowed the German economy, is one of many examples of this. Without response, these events can become negative self-fulfilling spirals.
Smaller companies are by their nature, highly exposed to their domestic economy. In our fund the sales exposure to Europe as a whole is almost 80%. Direct sales exposure to the UK is, of course, far lower but those ripples will have an impact and we will question our individual investment decisions as the impact of uncertainty and the almost inevitable slower economic growth takes its toll on sales. To counter this we look to invest in a large number of companies who have not just survived but thrived through Europe’s tough times. Where we take cyclical exposure it is with a substantial margin of safety on the valuation. One other threat that we are alive to is that of excess leverage and where our companies do carry debt, it is in combination with asset backing and predictable earnings streams.
REAL POLITICAL ACTION
As European investors, political shocks to a fragile economy are no new thing and each summer since the financial crisis we have had a different event that has prompted a series of emergency summits and eventually a response from the member countries and institutions.
It is vital – at this most critical juncture – that European leaders unite to do ‘whatever it takes’ to relieve unemployment, rebuild economic confidence and restore faith in the legitimacy and desirability of the European project. Hiding behind the European Central Bank and its president, Mario Draghi, is no longer an option: monetary policy alone cannot save Europe. The days of can-kicking and feet-dragging must come to an end if further populist uprisings are to be averted. All policy levers, including fiscal stimulus, must now be given serious consideration.
Despite the uncertainty pervading markets today, it is important to remember that Europe remains home to some of the world’s most advanced economies and to some truly outstanding companies. Long-term investment opportunities have not evaporated overnight. Indeed, there could well be great possibilities to invest in high-quality companies as a result of volatility in the days and weeks ahead. While some in the markets will lose their heads, we will look to remain composed and ready to take advantage of any sensible opportunities.