The biggest political risks in 2017 lie not so much with the UK’s negotiations over Brexit, but with the European response, believes Andrew Milligan.
In this interview with CFA UK’s magazine Professional Investor (PI) Andrew Milligan outlines his concerns over political risk in an uncertain environment.
PI: We are living in interesting times. Has political risk become more important in investment analysis?
Absolutely. Financial markets have always been affected by political decisions, usually short term noise but sometimes the start of important trends. The abolition of exchange controls in the UK in 1979, the collapse of the Berlin Wall a decade later, the 2001 entry of China into WTO – these began transformational changes. This year’s examples include the UK’s EU referendum and the election of Trump, putting these countries onto a very different path.
PI: What do you think will be the biggest political or event risk in the next year for markets?
We face a hurdle race in the coming year. Markets have to jump cleanly over all of them, as otherwise at the very least there is a painful shock, and potentially the start of something more serious. After the US election results, with the Republicans gaining control of the Presidency and Congress, we may see an end to gridlock in US politics. The important issue is whether this opens the way for a more forceful foreign policy vis a vis Russia, the Middle East and the South China Sea, as well as global trade and immigration matters.
“ Our job as investors is to be on the right side of the big themes, rather than making highly accurate forecasts.”
We should not forget either that after three peaceful transfers of power within the senior echelons of the Chinese communist party, the current leadership is breaking precedent with its planned changes. Will this be smooth as well? Of course, the biggest political risks in 2017 lie with Europe, not so much the UK’s negotiations over Brexit but the European response. What sort of Europe do the various governments wish to adopt, a much more integrated federal version or a looser less regulated trading style? Populist pressures appeared in the UK and the US in 2016, is it the turn of Europe in 2017?
PI: How hard of an exit will Britain have from the European Union, in your opinion, and what will be the implications of that?
I think the problem with using such shorthand as ‘hard’ or ‘soft’ for the UK’s Brexit negotiations is that while it simplifies the issues for a tabloid newspaper audience, or opposition politicians, the reality will be much more fluid and nuanced. Brexit is a process, not an event. It will be the most complicated undertaking for any UK government in 70 years. We can already see four possible phases lasting say a decade: between now and triggering Article 50, which begins two years of negotiations on exit, probably followed by a provisional agreement lasting several years, before the final exit. The EU will not compromise its four freedoms to accommodate the UK’s wish to control immigration, so the UK will look for a bespoke arrangement. Will European governments agree; does politics trump economics, or vice versa? The big picture for the UK – and investors in UK assets – is that it needs to raise its competitiveness and/or the quality of its goods and services to reduce its trade deficit and rebalance its economy. The big picture for the EU is does EMU fall apart under the weight of populist pressures.
PI: How easy or difficult is it to make accurate predictions about future economic trends and themes? How can we forecast the future?
It is quite understandable why there are so many jokes about economists and forecasting: “Prediction is very difficult, especially if it’s about the future.” Our job as investors is to be on the right side of the big themes, rather than making highly accurate forecasts. One can analyse and then take full advantage of some of the key drivers of modern markets: demographics, innovation, populism, regulation, central bank intervention, quantitative finance, to name a few. We sum it up in our refrain: a world of low numbers – low growth and inflation, low rates and yields. My degree was in economics and economic history, and the latter part is extremely important – to have any hope of forecasting the future, we have to understand past history and current trends.
“ To have any hope of forecasting the future, we have to understand past history and current trends.”
PI: In a low growth environment, where do you see opportunities for investors?
The most difficult question left until last! As ever timescales are important, are we investing for the coming year, the coming few years or the coming decade? Worrying imbalances are building in many parts of the world economy which will be triggered sometime. In the near term, we can look for income from a range of assets – developed and emerging equities, US and European high yield bonds, some emerging market debt, lots of real estate in Europe and the States. Growth opportunities will depend on the balance of decisions taken by Trump – a focus on fiscal expansion or trade barriers? In the longer term, build up cash looking to invest when valuations are a lot better.
Andrew Milligan is head of global strategy at Standard Life Investments, leading the team of economists and strategists advising the company on asset allocation decisions. Before joining the firm in 2000, he worked at H.M. Treasury, Lloyds Bank, several stockbrokers and Aviva. He received an OBE in 2015 for services to innovation and the economy. For several years he was a governing board member of the UK’s innovation agency Innovate UK. He is currently a member of court of Heriot Watt University and sits on the board of Edinburgh Business School. He is chair of Work Place Chaplaincy Scotland.