Brexit Britain: Here’s what the financial markets are telling us about the economic effects of leaving the EU: Professor David McMillan


The UK’s FTSE100 was the only market to remain below its pre-pandemic value throughout 2021 (Image: Carl Court/Getty Images)

But comparing the state of financial markets in Britain with that in Europe and the US may give us a more accurate picture. That picture is complex, but disturbing.

Of the three broadly similar economic areas, UK GDP growth has been lowest since 2016, falling the most at the start of the pandemic but rising fastest in the recovery.

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Economic conditions remain mixed and reliant on restrictions: UK retail sales fell in December due to the impact of Omicron, while overall GDP grew. However, although trade between the EU and the UK in the year to October 2021 grew by two per cent, the equivalent figures between the EU and the US and the EU and China are 18 and 17 per cent. cent, respectively.

We can also look at business investment in the UK, which leveled off in 2016 and remains around ten percent below its pre-pandemic level, or the Purchasing Managers’ Index (PMI), which is moderate but positive, as indicators of whether companies expect the economy to grow.

The financial markets, however, provide the best place to consider our long-term prospects. Financial markets look to the future, revealing whether investors believe future performance will improve and expressing confidence in an economy. Ultimately, where are investors willing to put their money?

Stock prices rise and currencies become strong and stable with better times ahead, while the bond market provides coverage for any rising risks.

So what are the financial markets telling us?

The focus inevitably falls on a country’s main stock market index. During 2021, the US S&P500 rose by around 27 percent (a similar value is recorded for France’s CAC40); for the US Dow Jones and the Euro Stoxx 50, growth was around 18 percent.

The UK FTSE100 figure was 14 percent and is the only market that remains below its pre-pandemic value. So we see growth, as the economy recovers from the pandemic, but slower in the UK than in other markets.

At the time of writing, an investment made in early 2020 would have returned 37% in the US, 13% in Europe, but less than 1.5% in the UK.

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Stock price-to-earnings (p/e) ratio is an alternative judge of investor confidence. A high ratio indicates that investors are willing to pay more for a stock now with the expectation of strong future performance.

The p/e ratio of the UK is lower than that of the US, France and Germany. This means that UK equities are relatively undervalued, indicating doubts about the expected growth of the UK economy.

This has prompted Goldman Sachs to suggest investors buy cheap UK stocks as they inevitably need to catch up. However, they made a similar statement in late 2020! International investors remain less convinced and more likely to withdraw money from the UK, with £4.4bn leaving UK equity funds in 2021 and £21bn since 2016.

Consideration of capital flows brings us to another key market: currency. While the stock market represents an indicator of confidence in expected economic performance (ie, of publicly traded companies), the exchange rate reflects a broader measure.

Investors looking for UK assets, whether they are shares, bonds, property, land or companies to acquire, need pounds first. Capital flows reflect international investor confidence in the entire economy, with large sums of currency traded daily.

In its latest survey, the Bank for International Settlements (BIS) noted that $6.6 trillion in foreign exchange is traded every day, including $844 billion in pounds. How has the pound fared against the US dollar compared to the euro?

During 2021, the pound fell by a small margin, around one percent, while the euro fell against the dollar by seven percent (with a corresponding rise in the pound against the euro). This looks good and indicates some confidence in the UK. But not from a broader perspective, with the pound eight per cent weaker and the euro virtually unchanged since 2016.

And the evidence points towards greater volatility in the pound during 2021. Statistical measures of fluctuations reveal that the volatility of the pound-dollar rate is more than 20 percent greater than the euro-dollar rate and with a coefficient of variation eight times higher. This increased volatility indicates nervousness among investors, who are rushing to withdraw money.

Higher volatility also comes with higher risk for investors and costs for exporters and importers, with changes in the pound affecting the value of both portfolios and assets.

Are other markets signaling investor concerns about the long-term performance of the UK economy? Here, we can look at the bond market for government debt.

Investors buy bonds because they offer a guaranteed return. Concerned investors buy bonds, confident investors sell them, as higher yields can be earned elsewhere. Since there is an inverse relationship between bond prices and yields, confidence in the UK’s future performance would manifest itself in higher yields.

This is what we see in the short and medium term. But with long-term yields lower than medium-term, investors are buying insurance, showing doubts remain.

The UK remains a major financial center. It is the largest market for forex trading, accounting for 43 percent of trade according to the BIS survey cited above. The London stock market witnessed a surge in new stock listings, with £13.7bn raised in the first three quarters of 2021, particularly from financial and technology companies. This is more than other European markets individually, though less collectively, and London is no longer the largest European stock trading market.

Through this mixed news, the evidence from the financial markets leads to two clear conclusions.

UK stocks underperform major competitors, leading them to be cheap. And the foreign exchange market is experiencing increased volatility, which introduces additional risks and costs to the economy. Overall, our long-term future looks uncertain.

David McMillan is Professor of Finance at the University of Stirling School of Management.

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George Holan

George Holan is chief editor at Plainsmen Post and has articles published in many notable publications in the last decade.

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