Brexit with Trump

Just six months ago, the probability of victory for each of Brexit and Trump were 30% – and the odds on the double were thus 10-1 against. The world going into 2017 looks a very different and more uncertain place than it did a year ago.

However, Trump’s victory provides the UK with an opportunity to gain a substantially better agreement with the EU than it would have done with a Clinton victory, even though Mrs. Clinton may well have leaned on the EU countries to give the UK a sensible deal.

Trump’s victory has many European governments feeling considerably less secure. With his outspoken admiration of Vladimir Putin and his tendency to see foreign relations as a zero-sum game rather than mutual gains through international agreements, Trump’s view of NATO and European security is very different from his predecessors. For those in Eastern Europe, Putin is today a bigger threat to their borders and US military support less likely to be forthcoming.

One of the few cards that the UK holds in the Brexit negotiations is it deep and unwavering commitment to the military defence of its European allies, and despite the harsh words used against the rest of the EU from those seeking to leave the EU, their military support for the EU has not changed and they have consistently voiced this before, during and since the referendum. That support has now become much more meaningful and valuable, especially to those countries in the former Eastern Europe. 

The desire to punish the UK for its audacity to leave the EU is now (post Trump) more likely to be to seek a strong agreement with a staunch ally who is also a nuclear power. On the Maslovian hierarchy of needs, the basic security of your country is a far more powerful force than the continued existence of a financial passporting system or some controls on the uninhibited movement of people between countries.

In addition, once again, through their votes, the UK and the US have shown the similarity of their thought processes (a clear parallel being  the ascensions of Thatcher and then Reagan), which often baffle European minds.  Maintaining a close and friendly relationship with the UK is likely to be helpful to Europeans in understanding and interpreting the actions of the US. Trump has spent time in the UK (though mostly in Scotland), has openly identified his success with Brexit and did

promise to put the UK at the front of the queue for a trade agreement post-Brexit, following Obama’s threat that it would be at the back of the queue. Though of course this would be strictly on Trump’s terms, and have almost no cost to US jobs – it would enable him to show that there are some trade deals he will do if they are right for the US. The EU-US trade deal, already stymied by European doubts before Trump’s  success is now dead in the water.

Trump’s victory will change the world in many ways, but one of the more surprising ones is likely to be that the UK obtains a better exit agreement from the EU than would have occurred without Trump.

The giants of Multi-Asset Absolute Return fund sector

This was originally published in Investment Week

In recent years, the fund sub-sector seeing the greatest inflows has been the Multi-Asset Absolute Return sector, home to several of the largest individual UK funds. The attraction to investors of these funds has been the promise of returns well above cash for limited amounts of volatility, and sophisticated investment processes aiming to exploit opportunities across all asset classes. The giants of the sector are shown in the table.

AuM £m Fund 1 yr ret % 3 yr ret % 5 yr

ret %

Launch date
26,560 SLI GARS -2.4 7.7 23.2 29/01/08
9,824 Newton Real Return 11.2 15.8 28.4 01/04/04
7,197 IP Glob Target Return 3.0 16.2 na 09/09/13
2,562 AIMS Target Return -0.4 na na 01/07/14
1,571 AIMS Target Income 2.6 na na 30/11/14

Source: IW 10/10/16, fund factsheets

Funds such as Fulcrum Diversified Absolute Return and Goldman Sachs Global Absolute Return have similar objectives and approaches but have not yet seen investor flows to the same extent.

All of Newton, SLI and IP have, to date, broadly achieved their return and risk objectives over the recent 3 or 5 year horizons, but it is noticeable that none of these funds have generated much performance from the large decline in sterling post-Brexit (Newton have held a relatively high sterling weight in recent months.  This is in stark contrast to most of the more traditional fund sectors where beta returns predominate, which have been significant beneficiaries of sterling’s fall.

Hindsight shows that, once again, where funds flow from investors is heavily focussed in one sector, that sector tends to lag in performance behind less-favoured sectors.

Newton Real Return is the Grandfather of the sector, launched over 12 years ago, aiming at long term returns of cash +4% before fees over rolling 5 year periods and positive returns over rolling 3 year periods. They aim to achieve this by investing predominately in equity and bond markets, and control net market exposures through active hedging of equity and currency market risk. It can be best seen as a balanced fund that actively hedges its total equity exposure. Iain Stewart has been in charge since the fund’s launch and has delivered a positive return in every calendar year to date. This was particularly noteworthy in 2008 when the portfolio was well prepared for collapse in equity markets, but performance was disappointing in the 2012 to 2015 period when he held a relatively cautious view on equity markets. However, the last 12 months have returned 11.2% as the exposures to long duration government bonds and to gold have paid off handsomely, in addition to strong equity sector selection performance. This recent good performance has more than recovered the prior lagging performance, whilst maintaining low volatility.

SLI Global Absolute Return Strategies is the Big Daddy of the sector, the largest fund in the entire UK funds market, launched in early 2008, aiming at returns of cash +5% before fees over rolling 3 year periods. It uses a combination of traditional assets such as equities and bonds and modern strategies that make use of advanced derivative techniques, which give access to other asset classes such as interest rates, volatility and inflation. These techniques mean that the gross positioning of the fund has often exceeded 400%, though the rigorous risk control measures have meant limited portfolio volatility over the life of the fund. It is most easily understood as a hedge fund, though without the performance fees. The portfolio consists of around 40 different “ideas” which are each expected to deliver positive returns on a 3-year view, which are then blended together. For an advisor or end-investor it does mean that it is difficult to understand how the fund is actually invested in contrast to the far more straightforward portfolio positioning used and reported by Newton.

An otherwise very steady performance record has been damaged by the fund’s struggles over the last year, with a loss of 2.4% over that period. The team have struggled with their key long term market view of a stronger US economy, and this view was reflected in many of their positions, in particular their short duration position in US bonds, the significant long position in the dollar and a US Banks v Consumer Staples equity position. Some fund research houses also have cited the sheer volume of assets now managed by the GARS team (over £150bn) as a possible factor behind its declining performance in recent times.

Invesco Perpetual Global Targeted Returns is more like the oldest son in the sector. It was launched when three of the GARS investment team left SLI to move to Invesco Perpetual in 2013 and it adopts a similar investment process, though tends to operate with fewer individual ideas at any one time. Like GARS its gross positioning is substantial and makes considerable use of complex derivative techniques and aims to generate a positive return of cash +5% before fees over rolling 3 year periods with less than the volatility of global equities.  One difference in approach is that many of the talented equity managers at Invesco, such as Mark Burnett, manage equity “sleeves” for the GTR team thereby adding an extra element of return from individual stock selection that has absent at SLI.

AIMS Target Return and Target Income are the younger son and daughter of this family. Target Return was launched in July 2014 and Target Income in November 2014. Euan Munroe who built the original GARS fund is now CEO of Aviva Investors and the whole of their business is now centred around providing ideas for the multi-strategy fund range. The Target Return fund, like the others in the sector seeks positive gross annual returns of cash + 5% over rolling 3 year periods. In its objectives and approach the fund is similar to the SLI and IP offerings.

The Target Income fund, unique within the sector, seeks a pre-tax income return of cash +4% pa paid monthly, whilst maintaining the capital value after fees, regardless of market performance. In order to generate the high level of income targeted, a large part of the portfolio has to be invested in high-yielding equities and in bond markets, typically taking on some credit risk. Market hedging, multi-asset ideas and techniques are then added to the portfolio in order to seek to produce an absolute return profile.

Neither fund has yet built a 3-year track record – both performed well from launch until April 2015, but have struggled to make further gains since then.

In the down phase of the trade deals cycle

The UK’s referendum decision to leave the EU, leaves it seeking new trade deals not only with the rest of the EU but also with the 50 or so nations with whom the EU has trade deals in place. The new minister for International Trade (Liam Fox) has also indicated that he would be keen to see trade deals with the US, Canada, Australia, New Zealand, India and China. Without trade deals, countries may impose tariffs on imports of goods and stiff regulations on imports of services.

Not only does the UK have very few experienced trade negotiators, since this has long since outsourced to the EU but the UK’s demand to make trade deals comes at a most inopportune time in the trade deals cycle. Recent events indicate the momentum and desire for agreeing trade deals have reversed.

The trade deals cycle began to turned upwards in 1986 when talks for the Uruguay Round within GATT began – with the free market philosophies of Thatcher and Reagan leading the way for countries to reduce the barriers to international trade that were in place. The talks concluded successfully in 1994 with an agreement that reduced global tariffs on goods substantially, so boosting the volume of trade. Other key free trade agreements have been NAFTA which came into force in 1994, the development of the EU Single Market in the 80s and 90s, where Mrs Thatcher did much to drive progress.

As part of that agreement the World Trade Organisation was set up in 1995 to take over GATT’s responsibilities for matters relating to international trade. In 2001 the WTO initiated the Doha Round, at the same time as China was admitted to membership of the WTO. The accession of China to the WTO saw a further dramatic rise in global trade volumes until 2008.

In hindsight this was peak of the trade deal cycle and agreement between nations to reduce trade barriers. No significant progress has been made since then.

The aim of the Doha Round was to further reduce global trade barriers especially within agriculture and services. It had an original deadline for an agreement by 2005, but was plagued by difficulties – negotiations collapsed in Geneva in 2008 and the Global Financial Crisis has meant that since then national governments have been unwilling to make concessions that might harm their citizens.

In recent years, following the collapse of the Doha Round there have been three attempts at major non-global trade agreements. These are between (i) the US and the EU via the TTIP (Transatlantic Trade and Investment Partnership) talks, launched in 2013, (ii) the US and other American and Pacific nations via the TPP (Transpacific Partnership) and (iii) Canada and the EU via the CETA (Comprehensive Economic and Trade Agreement) talks, negotiated between 2009 and 2014.

Of these TTIP talks have got stuck – the original intention to conclude by 2014 has been extended to 2019 but across Europe there is increasing unhappiness at the secrecy of the proposals and the progress of negotiations. The TTP talks produced an agreement but requires ratification from the US – during the campaign Donald Trump has stated his opposition to this and other trade agreements and would not ratify it, and Hillary Clinton, having been a supporter of it when in government has now said that she would not ratify it. The CETA has recently run aground as EU ratification of the Treaty requires each of the 28 member states to ratify it individually and Belgium cannot do so without the agreement of the Walloon parliament, which is currently firmly opposed to doing so, seeing as a further dangerous step towards globalisation.

Trade deals have lost their political support and the momentum of the trade deal cycle is now firmly down. Though the UK and the rest of the EU ought to be able to agree on a post-Brexit trade deal given the economic benefits to both sides, for the UK to conclude many other significant trade deals is likely to be a very long and arduous process.

The UK’s post-Brexit need for free trade deals will prove to be cyclically poorly-timed and a negotiating weakness at a time when countries are growing increasingly suspicious of the benefits of such deals.

 

A hard Brexit please

This week the government made clear its decision regarding the sort of Brexit it will be seeking. The red lines of control of immigration and withdrawal from the European Court of Justice’s jurisdiction represent the “taking back control” that the Leave campaign promised.

The other 27 countries in the EU have made abundantly clear that the price of Britain denying freedom of movement is that it cannot continue to be inside the single market –  the working definition of a hard Brexit. Thus some sort of agreement on how trade will be conducted between Britain and the EU will be required.

There appear to be two key areas to be negotiated before Britain actually leaves – (i) a transitional trade agreement pending a more permanent agreement which might take many years to conclude and (ii) an agreement on the financial services sector and the current passporting system.

It is interesting to note that the red lines regarding “taking back control” do not include the subject of the UK’s net contributions to the EU budget and it seems that Britain may be prepared to pay (financially) for a transitional trade agreement and agreement over continued financial services passporting. Whether this would be acceptable to the EU countries is not clear – the current payment from the UK of £18bn per year (which would presumably be the maximum that Britain would be prepared to pay), does not go very far when spread around 27 countries.

Whilst now is the time of maximum pessimism about Brexit negotiations -before formal talks have even begun and with each side setting out their red lines – Britain has lost goodwill in Europe over the last week following policy ideas announced at the Conservative Party ‘s regarding foreign-born workers.

Both Merkel and Hollande have made clear that it is important for them that Britain should be not be seen as having won anything by deciding to leave the EU, and though it is quite possible neither will be around to have much influence over the negotiations, their fellow-countrymen are unlikely to have very different ideas.

With important votes and elections in Italy, Spain, France, Netherlands and Germany over the next 12 months, little progress should be expected in the Brexit talks in that time period. This will prove negative to the world’s view of Britain – the pound has continued its post-referendum decline this week, and gilt yields have risen in anticipation of the higher inflation this is likely to create in the British economy.

International investors will at best defer further investment into the country and at worst begin making adjustments to their factory and office locations to reflect a Britain outside the single market. Any good news regarding the benefits of new trade agreements with other non-EU countries will have to await the outcome of talks to agree our relationship with the EU.

By announcing when it expects Article 50 to be triggered and its red lines, Britain has now entered a period of massive vulnerability for its economy. Maintaining the goodwill of the other EU countries should now be a key objective of foreign policy.

How do you like your Brexit – hard or soft?

“Brexit means Brexit” has been Theresa May’s equivocal line since the referendum. It has become clear that this actually means that Britain will leave the EU – the manner of that departure, however, remains unclear.

The difference between a “hard” and a “soft” Brexit centres around the relationship with EU single market which allows goods to move around the EU unhindered. A soft Brexit would allow Britain to remain in the single market, whilst a hard Brexit would see it leave both the EU and the single market.

All UK politicians agree, at the very least, that Britain should aspire to “have access to the single market”. This is, however, a meaningless form of words since all countries in the world (with the exception of North Korea) are able to sell their goods to buyers in the EU if they wish – ie they have access to the single market. What is more important is to have “tariff-free access to the single market” – provided a nation is a member of the WTO (World Trade Organisation) then a maximum tariff (or a tax) of 10% can be applied to trade in goods between them. In general, this tariff will be applied to all goods imports unless there is a separate trade agreement between the importing country and the exporting country. There is also considerable bureaucracy involved in proving that the goods meet any national standards or regulations of the importing country.

Being “a member of the single market” means that there are no tariffs and no bureaucracy – if the product meets EU standards then it can be freely sold anywhere inside the EU, and in practice the slightly larger EEA which includes Norway and a few other small countries. The major disadvantage of not being inside the single market is the bureaucracy involved at border points when goods cross in to the EU, which means higher costs for business. This is a particular problem for the border between Northern Ireland and the Republic of Ireland, which is currently completely open.

Being inside the single market is a real prize for business, is the main reason that Mrs Thatcher wanted Britain to be a member of the EU, and has been the UK’s main focus of political activity while a member.

Given the referendum result, the best outcome for Britain is not to be a member of the EU, and thus able to control its own borders (by ending freedom of movement to EU citizens) and write its own laws, but to retain membership of the single market. In fact, this would probably be the best outcome for every EU member and is why the EU negotiators will not agree to it.

Since Article 50 has not yet been triggered and negotiations have not yet started, both sides are talking tough and making clear that they would not be unhappy if nothing is agreed and Britain leaves the EU with no new agreement about trading relations in place. This is assumed by both sides to be that Britain would leave the EU and become a member of the WTO in its own right, rather than as part of the EU. This would be the hardest Brexit – access to the EU but with 10% tariffs applying to all trade (though Britain could unilaterally set a zero tariff on imports if it so wished). In any negotiation, the side least able to accept the situation if the event of no agreement has the weaker hand, so both sides are saying publicly that this would not be a problem for them.

Many in the UK claim that the €90bn trade deficit in goods that Britain has with the rest of the EU, means that the EU would suffer more, in money terms, from no agreement, whilst those in the EU point out that with 47% of Britain’s goods exports going to the EU, while for the EU’s leading exporter, Germany, the UK represents just 7.5% of their exports, the effective impact of tariffs on the British economy would be much greater than on the rest of the EU.

In practice, the obvious solution for both sides is tariff-free access for goods – it is the closest solution to the current situation and any tariffs would be negative for both parties. Provide the negotiations are conducted on a friendly basis, this should be the outcome, and can be construed as a medium-hard Brexit.

In financial services, where the UK has a large trade surplus, the EU operates a “passport” system, if a firm is regulated by an EU country it can apply to have a passport to provide those services in the rest of the EU. British firms are very keen to keep these rights, but if outside the EU they are dependent on the EU agreeing to this. France and Germany are both keen to have the power and the jobs from these financial services in their own countries, and so the price for maintaining these passports will be high. It is likely that the UK would have to offer concessions on the freedom of movement of people to achieve this – this would be a difficult compromise for the British people and politicians to accept.

Britain does not hold too many cards in the negotiations and a hard Brexit looks the most likely outcome.  Provided there is rationality and goodwill on both sides, tariff-free access for trade in goods should result, but an agreement on services, which is of greater importance for Britain will be much tougher to achieve.

A badly-timed referendum

David Cameron never really envisaged losing the referendum, hence he paid no attention to the timing of it should he lose it. However, the state of national politics across many European countries is febrile and within twelve months it is quite conceivable that the four largest countries in the EU will all have different leaders and potentially these new leaders will all be from different parties than rule today. This will have a major effect on the outcome of the exit negotiations.

In Germany the next general election is set for September next year. Ahead of the 2013 election Angela Merkel indicated that she would step down before the next election – this promise has not been repeated since that election but she is yet to confirm that she will stand for re-election next year. She is one of the most experienced and highly regarded politicians globally but her stance over the migrant crisis, being happy to accept over 1 million migrants into Germany over the last year or so, has damaged the standing of her and her CDU party in Germany. Should she decide to stand down, the EU will lose its most powerful politician and Germany’s influence within Europe will decline; should she decide to stand again she might find that her CDU party garners less seats than the centre-left SPD party, her current coalition partner. Recent local and regional elections have been notable for the surge in popularity of AfD, a party that began life on an anti-euro platform but which in recent times has shifted right to become firmly anti-immigrant and anti-Muslim. The proportional voting system in Germany means they are likely to gain seats in the new Parliament and become a meaningful force in German politics

In France, there will be a Presidential election in April. The two-stage process, where the two candidates with the highest number of votes in the first round are the only ones on the ballot for the second round, combined with a large number of potential candidates make for a lot of uncertainty. Currently Marine Le Pen of the Front Nationale, whose major policy is firmly anti-euro and anti-immigration, looks set to gain the most first round votes and be in the final ballot where she would be expected to lose against most others, but it is very unclear who the other candidate might be. From the centre-right of French politics Alain Juppe, a former prime minister and Nicholas Sarkozy the previous President are the two leading candidates, whilst from the left President Hollande is very unpopular and has yet to decide if he will stand again – two members of his government, Manuel Valls and Emmanuel Macron have already announced they are candidates. The current polls indicate that should Hollande stand he would fail to reach the second round, which would be a huge political embarrassment for him.

In Italy, the current prime minister Matteo Renzi has called a referendum on some constitutional changes to reduce the powers of the Upper House and regional governments, that he feels are necessary to deliver structural reforms to the Italian economy. The referendum result is likely to be close – it will be held between November 20 and December 4. He has repeatedly said that he will resign as prime minister and leave politics if his reforms are rejected. On current polling the anti-EU and anti-establishment Five Star Movement is leading though their leader, Beppe Griilo is himself not permitted to be elected to parliament due to a previous conviction

In Spain, there was an election in December 2015 but this produced an inconclusive result and it had not proven possible for any combination of parties to agree on a forming a government with a parliamentary majority. Mariano Rajoy the prime minister before the election has continued in office without sufficient votes in parliament to pursue his policies. Nine months of inter-party talks have failed to resolve the situation and the most likely outcome is another election soon. However current polling indicates that the likely outcome would remain very unclear.

With these four large Eurozone economies facing such political uncertainty, in terms of who will lead and what their policies will be, it seems unlikely that Brexit discussions / negotiations will achieve much forward momentum for some time. For markets, European economic policy will remain dependent on ECB decisions as little progress from fiscal policy or structural reforms can be expected either.

A safe assets bubble

The financial history of the 21st century is the story of bubbles and the after-effects of bubbles in different asset markets. In March 2000, the TMT bubble burst leading to a near 80% decline in the NASDAQ Composite Index over the next few years. The response of the Federal Reserve took interest rates down to 1% and held them there until it was clear that the economy was recovering – this policy of very cheap US dollar borrowing led directly to (i) the US housing market bubble and (ii) explosive growth in the financing of a wide range of assets, the emergence of the “shadow banking” sector and a bubble in the credit markets. The Global Financial Crisis in 2008 burst those bubbles and led to a severe global recession as the world’s financial system seized up. The Chinese government decided to seek to offset the damage to its economy with an enormous surge in infrastructure spending which created bubbles in their equity market and in many commodity markets. The weakness in global growth since then has meant that the recovery expectations of central banks have been consistently disappointed and led to them pursuing Quantitative Easing (QE) in ever-increasing amounts.

To date the 21st century has suffered bubbles in developed market equities, real estate, credit, emerging market equities and commodities – all assets that are to some extent seen as risky in investors’ portfolios. However the continued and repeated application of QE has now created a bubble in government bonds – the quintessentially “safe” assets for investors.

The hallmark of a financial asset bubble is when traditional valuation concepts are ignored by investors and the bubble asset is purchased because of a belief in the greater fool theory – that is confidence that when you want to sell there will be a buyer prepared to pay an even higher price – in these situations asset prices tend to rise to far higher levels than sensible investors can imagine.

The FT last week calculated that some $13.4 trillion of global government bonds now offered negative yields – a negative yield means that investors are paying to lend money to governments. They know that buying these bonds will result in them losing money if they hold them to maturity. Their rationale for continuing to hold them must be either (i) they are forced by law or regulation to hold them, (ii) they will suffer worse negative yields if they sell them and try to deposit the cash or (iii) they believe they will be able to sell them at a higher price (and more negative yield) to another investor in the future. Most of these negative yields are in Europe and Japan but even in the UK and the US most government bonds yield less than 1% and all global index-linked government bond yields offer negative real yields.

With central bank QE programmes continuing to be forced buyers of government bonds, the marginal buyer of these bonds is not price-sensitive and so a case can be made that prices of these bonds may go even higher, but investors should be aware that these are bubble valuations in government bond markets.

The bubble is most likely to be burst by the very success of these QE programmes. They are designed to raise the rate of nominal growth in the economy, which to date has not occurred, and if that happens then investors will once again demand higher and positive yields than are available today. The scope for losing money in safe government bonds will then become manifest. As an example the UK Treasury 4% of 2060 was issued in late 2009 at a price of £96.25%, in October 2015 was trading at £136.65% and last week traded at £195.57%. Investors who bought it last week would receive an income yield of just over 2% and know that the bond would be redeemed in 2060 at a price of £100%, losing 95 points of capital value over 44 years.

As each bubble in risky assets in this century has burst, investors have flocked to their safe asset, government bonds. This is the asset class that has not disappointed since interest rates peaked under Paul Volcker in the US in 1981 – this 35 year bull market has delivered extraordinary returns for relatively little risk. The future will not, though, be the same as the past – instead government bonds will increasingly offer return-free risk. When this reversal occurs investors will need to unlearn the lessons of the last 35 years in markets and deal with a new reality – a return to inflation, rising yields and falling government bond prices.

A tide in the affairs of men

Over the last 100 years there have been two turning points in the evolution of the main economic philosophy that have supported economic policy in the UK and the US – the third such turning point appears to be now in progress.

In 1936 Keynes published his General Theory of Employment, Interest and Money in which he demonstrated that the economy could be in a state of equilibrium but with very high levels of unemployment. His policy prescription that the government make up for insufficient private sector demand by borrowing to fund public sector investment spending was the first time that an economist had argued that there was a key role for government within economic policy. This prescription was adopted in both the UK and the US (Roosevelt’s New Deal) in the next few years to deal with the Great Depression of the 1930s. The post-war economic policy conventional wisdom was that governments had a legitimate and necessary role to play by intervening in the economy in order to boost growth.

In 1976, the UK was forced by the weakness of its economy, to go and borrow money from the IMF and put in placer what would now be called policies of austerity. Most famously, the then Prime Minister, James Callaghan said “We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists …”. This was also the year that Milton Friedman received the Nobel Prize for his work on the importance of the money supply in generating inflation and marked a key change in mainstream economic orthodoxy which led to the rise of Thatcher and Reagan who looked to roll back the influence of government in the economy and re-focussed the target of central banks’ policy on containing inflation rather than supporting growth. Terms such as economic liberalism and free market capitalism also reflect the same direction of economic thought and in particular the deregulation of the financial sector that has marked economic policy in both the UK and the US from that point. Globally, free trade was a concept that dominated international policy-making as it was seen as both containing inflation and boosting growth.

In 2016, it appears that the tide of economic ideas is once again turning, and once more it is led by the UK and the US (with the UK again just a little ahead). The motto of the Brexit Leave campaign to “take back control” and of Donald Trump’s campaign to “make America great again”, are both calls to move away from the economics of free markets and the philosophy of free trade.

As in the 1930s, this follows a period in which a laissez-faire philosophy has not delivered improved living standards for the average person, but instead seen the share of wealth amongst the very richest in society rise sharply, boosting inequality. Interestingly is the right-wing of political thought that have understood and sought to exploit this. Trump’s calls to fight immigration and renege on trade deals have strong appeal to the (white) working classes who have suffered most the globalisation of the world economy. Even in the UK, the words of the incoming prime minister have pointed to the need for business to work for all sections of society, rather than the elites. Central banks around the world have for a few years now quietly been pursuing policies designed to increase inflation rather than contain it, though without success to date.

We have passed the point of “peak free markets”, and changes in the direction of the dominant economic meme tend to be long-lasting (40 years going by recent experience). We should expect governments to become increasingly involved in the affairs of men.

For investors, the key correlation to note at these tide-turning points is for interest rates and bond yields. The history of greater government action in economies is marked by rising interest rates and inflation, with real returns from government bonds the key outcome. These were disastrously poor from 1936 to 1976 but have fabulous from 1976 to 2016. A long period of very poor real returns from government bonds is now at hand.

Three into two doesn’t go

By their nature, if referenda are to be used only for matters of the greatest import, a clear answer must be forthcoming and therefore only binary outcomes can be permitted. In fact, though the Brexit referendum voting slip had just Remain or Leave printed on them, the Leave campaign was a coalition of two different perspectives. Michael Gove and Boris Johnson wanted to leave the loss of sovereignty implied by being a member of the EU with its automatic imposition of any Brussels regulations, but did not wish to lose the ability to trade freely with the EU, particularly in financial services where the UK dominates Europe. Many in wealthy parts of the UK voted Leave for this reason. For Nigel Farage on the other hand, the key issue was control of immigration – the EU’s freedom of movement for people in the single market was not acceptable and many in the poorer parts of the UK voted Leave for this reason.

The UK thus finds itself in a situation of intransitive preferences, known as Condorcet’s paradox. This occurs when a society prefers A over B and B over C and C over A. For a single individual this is obviously inconsistent, but in a society of many different points of view, this state of affairs is quite possible.

The referendum shows that the UK prefers Leaving the EU to Remaining in it. However, leaving the EU requires that we have to choose between continuing to be part of the Single Market with its economic benefits and having constraints of the freedom of movement of EU citizens. EU leaders have made it quite clear that this is the price to be paid to be part of the single market.

Thus it is entirely possible that there is majority preference to Remain rather than no longer be part of the single market but have control of immigration, ie Remainers plus many of the richer Leave voters, and a different majority preference to Remain rather than not have control of immigration and continue to have full participation in the single market, ie Remainers plus many of the poorer Leave voters.

Theory shows that for society as a whole such intransitive preferences have no good solution and this is where the UK finds itself today – wanting to Leave but with no plan and the world laughing at it.

Boris Johnson, now in campaigning mode to be the next Prime Minister, proclaims that the UK can have both, but David Cameron has already admitted that the UK must choose. The next Prime Minister will thus have to choose between the interests of business and the City and the poor. As a Conservative the obvious course may be to save the interests of business, but such a course of action will further alienate the poorer sections of the country and boost the support for UKIP and its anti-immigration stance.

There is already speculation that France would be prepared to offer the new prime minister zero tariffs on goods (where the Eurozone has a large surplus with the UK) and controls on immigration from the EU but no passporting rights for UK banks in to the EU. This would be exactly what the Farage wing of Leave would accept, but do great damage to the City and Conservative supporters.

As ever in politics there will likely be a compromise with some damage to the UK’s access to the single market in services in exchange for some flexibility on EU freedom of movement.

In or Out – the UK’s European hokey-cokey

For the last 50 years the UK has had a tortuously ambivalent political relationship with the rest of Europe – the referendum will not resolve this. This is for reasons of both geography and history. As an island with nothing but sea to the west but a huge landmass to the east, the UK is both naturally separated, and hence different, from the rest of Europe and at the same time ineluctably tied to and influenced by what happens there. The UK is both a part of Europe and not a part of Europe. This is reinforced by the sharing of a common language with the largest economy in the world, so providing the US with its key gateway to the European continent. Half of the UK’s trade is with Europe, emphasising the importance of the relationship, and of course the other half is not.

Post-war history has highlighted the indecision of the UK with regard to its relationship with Europe. In the early days of inter-government discussions between the nations to discuss political and economic co-operation and integration in the 1950s, the UK was largely absent and played no part, believing such plans were of little interest or relevance to them. By the early 1960s this indifference had turned to concern as it became clear that important economic decisions were being made in Europe that were affecting the UK’s interests. Macmillan changed course and decided the UK needed to join the European project, but was dismayed to find that the UK’s entry was vetoed by de Gaulle’s. So the 60s was a decade of the UK banging on the door of Europe but not being allowed in.

Ted Heath’s premiership in the early 70s was built around heavy diplomatic efforts aimed at negotiating the UK’s entry into the Common Market. This was finally achieved in 1973 at which point domestic politics intervened and Labour came to power with an election mandate to renegotiate the terms of entry which had only just been agreed, and then to hold a referendum. The renegotiation delivered very little and the public voted 2 to 1 to stay in.

For most of her premiership in the 80s, Margaret Thatcher was a convinced pro-European, because she saw it as good for business, and it was she who pushed hard in negotiations with the rest of Europe to deliver the European single market – the UK at this time was consistently arguing for more European integration, with opposition from much of the rest of Europe!

This reversed dramatically in the 90s as Jacques Delors led the European drive towards monetary union and the creation of the euro. In the UK this was seen as a backdoor way of seeking greater political union and sparked the rise of the Eurosceptic wing of the Conservative party, which has been the key faultline within the party ever since. Major European initiatives since then such as the Schengen free travel area and the single currency have seen the UK opt out, while letting others move forward together in greater integration.

The Blair and Brown governments in the Noughties were keen to be seen as leading Europe, with both men seeking to extend British influence by positive engagement, but increasingly the UK media railed against Brussels bureaucracy and increasing European regulation.

David Cameron was forced, for reasons of maintaining short-term party unity, to cede a second referendum, and polls, with less than a week until the vote, show a nation badly split over whether to remain in or leave the EU.

Though the shorter term consequences of the vote will be significant, on a longer term view, the UK’s essential ambivalence in its attitude to Europe will persist.

A victory for Remain will be seen as a rather grudging acceptance that the economic benefits of staying in (which have been very real for the UK economy over the last 40 years) are worth the perceived loss of sovereignty and democratic accountability, but there are few in the UK who have made an emotionally charged positive case for Europe. The UK would continue to be in but the tone will be reluctantly in – the historic ambivalence will continue.

A victory for Leave, though at first sight a clear statement that the UK does not wish to be tied to Europe, will not bring to an end the need for close understanding of European rules. The most successful UK , in services, in order to trade successfully with Europe, will be forced to comply with whatever regulations the rest of Europe decides to impose, not just with regard to those specific industries but also more generally with regard to European laws, which the UK will have no part in deciding.

The UK’s destiny with Europe is thus set to remain halfway “In” and halfway “Out” – the UK’s European hokey-cokey. The referendum will be a significant event in the UK-European relationship but will not change that fate.