US stocks have rallied since Christmas on the back of an expected trade deal with China. If there is any disappointment, then shares would react negatively, but assuming President Donald Trump can pull off his ‘deal of the century’, then don’t expect a big rally. It’s all priced into this market.
What could be about to move markets is something that Wall Street resolutely refuses to take seriously, a ‘no-deal’ Brexit. That is to say the UK leaves the European Union on March 29th as planned but with absolutely no planning about what comes next. This is the doomsday scenario that the Bank of England has warned will seriously damage the world’s fifth largest economy with a significant downside for Sterling, UK share prices and London, the most important financial centre after New York.
I’ve compared this to the collapse of Lehman Brothers in 2008 in a recent article. However, I have been worried by the dismissal of this idea as somehow unimportant just because financial markets do not appear to be taking it happening seriously. Only today (Wednesday) the British government delayed a key ‘meaningful’ vote by lawmakers from the 13th until the end of the month, taking us ever closer to the fixed deadline of March 29th. It hopes to back parliamentarians into a position where they will accept the deal that they rejected by a huge majority just a couple of weeks ago, just because the default alternative will then be a ‘no-deal’ Brexit.
Market participants seem to be forgetting where the valuation of the US stock markets sit today, and what that means about the potential fall in the event of a true ‘black swan’ event. Last October, US stocks were more highly valued comparing total market capitalization to GDP than in October 1929 before the Great Crash. The subsequent 19.8 percent slump in the S&P 500 before Christmas Day has been eroded by a substantial rally since then, probably what is generally known as a ‘dead-cat bounce’ rally that will roll over at the first significant black swan event that confirms the resumption of a bear market.
I would class a ‘no-deal’ Brexit as likely to be one of these events, if only because so few market participants have any real knowledge of what it actually means. Basically, you have a sudden destabilization of one of the world’s largest economies. This is not Venezuela. The UK is the second largest economy in the European Union, a federation of 28 states deeply embedded in a single market and customs union, with a combined GDP second only to the United States.
A ‘no-deal’ Brexit will cause untold chaos for business both in the UK and across the EU. Bloomberg today belatedly published a review of what individual countries have done to prepare business.
The German Association of Industry and Trade Chambers chief, Martin Wansleben commented: ‘I don’t think you can really prepare for chaos’. In short, trade between the UK and its biggest exporters will be in deep trouble with borders unable to cope with the Common External Tariff that automatically comes into force on Brexit, and supply lines will back up. ‘We are, to put it bluntly, screwed’ in the event of a cliff-edge Brexit, said Simon McKeever of the Irish Exporters Association.
Sterling will fall in value and that will be inflationary and the Bank of England will have to put up interest rates to defend the Pound. This will further damage a teetering, over-valued UK housing market and frighten off foreign investors. Consumer confidence will slump and there will be shortages of supply in the shops. Multinational businesses will recoil from further investment in the UK, and many are already establishing continental bases to stay within the European Union.
Indeed, the long-term impact of the Brexit will also be severe. Leading UK electrical goods manufacturer Dyson has announced it is leaving for Singapore; the latest Nissan SUV will not be made in the UK; Jaguar Land Rover has established operations in Slovakia and Hungary; Ford is closing plants in the UK. There is not one single case of additional foreign direct investment due to the Brexit.
All this, and more, is coming to a screen near you at the end of March. Beware investing in an overvalued US stock market with this black swan looming on the horizon.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.