CIO Blog: Brexhausted

Investment Strategy – March 2019

UK Equities & Gilts Rolling 10-Year Forward Total Real Return, Annualised

Figure 1

Past performance should not be seen as an indicator of future performance
Source: Kleinwort Hambros, Barclays Equity Gilt Study 2018. Data as at 31/12/2018


Deal or No Deal still remains the question. While fatigue has set in from almost three years of Parliamentary debate at Westminster – and at dinner tables and water coolers – we still have no idea what will happen at the end of March 2019, less than a month away from the legal obligation to exit the European Union. Angst, shock, opprobrium and ridicule fill the air.

Nonetheless, the FTSE 100 is up 26% since 22 June 2016, the day before the Brexit vote, to the end of February 2019 in total return terms (i.e. including dividends). Many will argue this is due to large multi-nationals hardly being “British” companies; the plummeting pound helps their repatriated profits. Inconveniently for that line of argument, the FTSE 250 – more suitably “domestic” – is up 19% in that time.

Geopolitics tend not to matter in the short-term

Indeed, it is easy to draw the conclusion that one’s asset positioning should be defensive during times of heightened conflict or stress. However, financial history teaches a different lesson: geopolitics rarely impact equity markets over the next year or so. The data just does not support the “geopolitical tensions are bad for markets” hypothesis (see figure 2).

For example, the world was brought to within an inch of nuclear Armageddon during the Cuban missile crisis in October 1962 (markets were reasonably flat in the months leading up to the crisis). An investor in the S&P 500 – a US and global equity bellwether – would have been up 7% in the following month, up 16% over the next quarter and up 34% a year later. Khrushchev may have blinked, but investors were on a roll.

Though investors at the time were indeed relieved that the world did not end, it hardly meant an end to tensions. The Cold War was still very much in full swing, and less than two years later, in August 1964, the US Congress passed the Gulf of Tonkin resolution officially “authorising” the Vietnam War. With the US waging a tremendously costly war across the globe, one would imagine equities performed poorly. Once again, investors were rewarded by staying the course: the S&P 500 returned nearly 9% over the following year.

The experiences above are not isolated. Investing in the S&P at the advent of the Six-Day War in 1967 between Israel and its neighbours would have returned 13% over the next year. Investing when the Soviets invaded Afghanistan in December 1979 would have returned nearly 10% in the next six months, a return that shot up to 30% in the next 12 months. More recently, the Russian annexations of the Ukraine, the Brexit vote and the election of Donald Trump were followed by strong returns for investors: the S&P rocketed up by 17.3%, 15.0% and 14.8%, respectively, over the following 12 months.

For all the horror images, real-time press coverage and social angst, geopolitical crises simply do not appear to affect markets often. While some events can be linked to losses – the Arab-Israeli war of 1973 or the September 11th attacks in the US in 2001 – the real causes are often more nuanced (Bretton Woods in the early 1970s, and the bust of the nascent tech sector at the turn of the century).

Figure 2

Past performance should not be seen as an indicator of future performance
Source: Kleinwort Hambros, Bloomberg. Data as at 31/01/2019

Long-term geopolitical transformations are also poor guides for investing

If investors should look through the knee-jerk reactions to geopolitics, the question of long- term, transformational geopolitical change still remains. Here again, context is critical. It is true that Brexit – the cause célèbre du jour – does pose new and unexplored questions for the UK. However, so did World War II, the loss of the British Empire, the subsequent downgrade of the UK’s status as a pre-eminent global military and cultural power and dizzying social, demographic and technological changes over the last 100 years. None of them caused UK equities to lose their long-run return potential – and there is little historical evidence of these tectonic political transitions being useful markers for investment decision making (see figure 1).

Since the turn of the last century, UK equities have averaged 6.7% per year after inflation. And while equities tend to be volatile and can lose value dramatically – UK equites were down 57% in 1974, its worst one-year performance – over the long-run, let’s call it 10 years for the purpose of illustration, the asset class tends to deliver returns far outpacing all directly competing investments (i.e. cash, bonds).

Ten-year forward returns from equities have been negative in only three periods. The first was in between 1905 to 1913, in the lead up to WWI (i.e. 1914 to 1918). While the war was a factor of course, most the investment losses can be traced to huge inflation between 1915 and 1920, where the cost of living index increased at an annual average of 17%1, followed by the post-war economic collapse that decimated the British economy between 1919 and 1921 (the economy actually did relatively well during the WW1).

The second period where long-run equity returns were hit hard was in the late 1960s and early 1970s, once again a period of huge price increases, where annual inflation averaged above 13% (1970 to 1981). The cause this time was not war, though the geopolitical ramifications of the Arab oil embargo did cause skyrocketing oil prices. Arguably, however, a much more significant driver of the inflation was the collapse of the Bretton Woods gold-backed system of exchange rates and poor monetary policy that coincided with that exogenous shock.

The third period was brief, with 10-year equity returns being negative from market peaks in just two years, 1998 and 1999. The “dot-com” era, as it is known, is most remembered for the hundreds of companies promising to change the world by harnessing the power of the newly created internet. It led some investors to pay mind-bending valuations for promise and potential that remained largely unrequited.

Investment implications

One could (and should) surmise that excessive, double-digit inflation or overvaluation are much more salient sources of worry for equity investors – who must be long-term in their outlook – than geopolitics. And neither are significant worries for now. Inflation in the UK is at its lowest point in two years (~1.8%). Moreover, with demographics feeble and productivity frail – and with monetary policymakers armed with both powerful tools and a strong public mandate – this worry is minimal. Similarly, valuations for equities in the UK are arguably cheap, with the FTSE 100 currently offering a dividend yield near 5%.

This time is not different.




Source: Kleinwort Hambros, Bloomberg. Data as at 25/02/2019
1 Kleinwort Hambros, Barclays Equity Gilt Study 2018. Data as at 31/12/2018  


Important Information

This document is provided for information purposes only. It does not constitute and under no circumstances should it be considered in whole or in part as an offer, a solicitation, advice, a recommendation or a contract. It is intended to be used by the recipient only and may not be passed on or disclosed to any other persons and/or in any jurisdiction that would render the distribution illegal.

It is the responsibility of any person in possession of this document to inform himself or herself of and to observe all applicable laws and regulations of the relevant jurisdictions. This document is in no way intended to be distributed in or into the United States of America nor directly or indirectly to any U.S. person.

Information herein is believed to be reliable but the Kleinwort Hambros Group does not warrant its completeness or accuracy and it should not be relied on or acted upon without further verification. The Kleinwort Hambros Group disclaims any responsibility to update or make any revisions to this document. Opinions, estimates and expressions of judgment are those of the writer and are subject to change without notice. As such, the Kleinwort Hambros Group, Societe Generale and its other subsidiaries shall not be held liable for any consequences, financial or otherwise, following any action taken or not taken in relation to this document and its contents.

Investment Performance
Past performance should not be seen as an indication of future performance. Investments may be subject to market fluctuations and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest. Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments.

Legal and Regulatory Information
Kleinwort Hambros is the brand name for the following legal entities;

United Kingdom
SG Kleinwort Hambros Bank Limited, which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm reference number is 119250. The company is incorporated in England and Wales under number 964058 and its registered address is 5th Floor, 8 St James’s Square, London SW1Y 4JU.

Channel Islands
SG Kleinwort Hambros Bank (CI) Limited, which is regulated by the Jersey Financial Services Commission (“JFSC”) for banking, investment, money services and fund services business. The company is incorporated in Jersey under number 2693 and its registered address is PO Box 78, SG Hambros House, 18 Esplanade, St Helier, Jersey JE4 8PR. SG Kleinwort Hambros Bank (CI) Limited – Guernsey Branch is regulated by the Guernsey Financial Services Commission (“GFSC”) for banking, investment and money services business. Its address is PO Box 6, Hambro House, St Julian’s Avenue, St Peter Port, Guernsey, GY1 3AE. The company (including the branch) is also authorised and regulated by the UK Financial Conduct Authority (“FCA”) in respect of UK regulated mortgage business and its firm reference number is 310344. This document has not been authorised or reviewed by the JFSC, GFSC or FCA

SG Kleinwort Hambros Bank (Gibraltar) Limited, which is authorised and regulated by the Gibraltar Financial Services Commission for the conduct of banking, investment and insurance mediation business. The company is incorporated in Gibraltar under number 01294 and its registered address is 32 Line Wall Road, Gibraltar.

Kleinwort Hambros is part of the wealth management arm of the Societe Generale Group, Societe Generale Private Banking. Societe Generale is a French Bank authorised in FrancebytheAutoritéde ContrôlePrudentieletdeResolution, located at 61, rue Taitbout, 75436 Paris Cedex 09 and under the prudential supervision of the European Central Bank. It is also authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

Further information on the Kleinwort Hambros Group including additional legal and regulatory details can be found at: www.kleinworthambros.com

Any unauthorised use, duplication, redistribution or disclosure in whole or in part is prohibited without the prior consent of Societe Generale. The key symbols, Societe Generale, Societe Generale Private Banking and Kleinwort Hambros are registered trademarks of Societe Generale.

© Copyright the Societe Generale Group 2019. All rights reserved.

If you do not wish to receive this document in the future, please let your private banker know or call us on +44 (0) 207 597 3000. Telephone calls may be recorded.

Mouhammed Choukeir Chief Investment Officer Kleinwort Hambros