As the UK moves on to the next stage of the Brexit negotiations, Guy Stephens considers the future of the country as a financial centre and what this could mean for investors
Having spent some of the festive season taking stock and stepping back from the noise, the New Year has started very much in the same vein as beforehand. Trump is again defending his fitness to serve, North Korea has engaged in more sabre-rattling, markets continue to attain new highs, commentators are still squealing everything is expensive … but still nobody is selling.
We have identified two developments worthy of comment that may indicate a shift in sentiment and, by extension, are supportive of markets. Following the Brexit first stage agreement in December, we considered the financial bill to be a bargain and, consequently, this was the first feather in the cap of Theresa May for a long time.
She has subsequently been enjoying a rebound in her parliamentary standing. Many had speculated she would unleash internal turmoil if she sacked Damian Green, with David Davis threatening to resign. When it became obvious the ministerial code had been breached, Davis backtracked, handing Theresa May an opportunity to stamp her authority.
Her cabinet reshuffle is further evidence of her strengthening position, which must be positive for sterling, the Brexit negotiations and the UK's international standing although, admittedly, there is no evidence to support this as yet.
The other development that somewhat slipped under the radar just before the holiday was a declaration from both the Bank of England and the Financial Conduct Authority they are willing to allow banks and financial institutions with UK-based European subsidiaries to continue operating under the regulatory rules currently in place.
What this means is that, from the UK perspective at least, our oversight authorities are entirely comfortable with a ‘business as usual' relationship when UK-based overseas institutions are trading in Europe. These statements came shortly after Michel Barnier had said there could be no continuing of passporting.
So what this effectively says is the UK authorities are making trading arrangements as open and familiar as they are now - and it will be for the EU to prevent businesses from continuing to trade freely in Europe. If the EU insists on this, then all major financial institutions will need to set up subsidiaries within the EU and, as Barnier hopes, consider moving their European subsidiary from the UK to another financial hub in the EU.
The card that has been played here is a subtle but important one. Any bank in the EU, and the world for that matter, that wants to be considered a serious international player, will have a subsidiary in London precisely because that is where all the major banks of the world are also sited - specifically the big US banks.
London is the world's financial centre, not just because of geography, time zone and language but also as a result of infrastructure and administrative support, legally and technologically.
The EU may think it can attract players away from the largest international financial hub but, in reality, businesses will only do as little as necessary to comply with whatever rules transpire, while remaining fully represented at the top table in London, which is bigger than all the EU financial centres put together.
If the US banks remain in London, and English remains the language of international finance, then City workers and the UK financial services industry have little to fear.
There is a point where industry stands up to the politicians and bureaucrats and makes demands in unison. As the trade negotiations begin, with jobs, profits and, importantly, tax revenues at stake, businesses such as Airbus, the car industry, airlines, farming, fishing and financial services will be lobbying hard for the likes of Angela Merkel, once she has formed her coalition, to remember who votes for her and what really matters in this whole negotiation.
This is why a transition deal is almost inevitable and the whole Brexit process will be very drawn out. The UK consumer is very important to the economies of Europe - and Barnier will soon be reminded of that.
Returning to the seemingly now ever-present topic of ever-rising markets and ever-stretched valuations, for the time being, investors are remaining invested, mainly in equities and bonds, because there are few available alternatives. And so long as there are no dark clouds with respect to earnings on the horizon, everyone is prepared to ignore the valuation concerns and keep their fingers crossed.
When greed turns to fear
The gyrations in bitcoin throughout December show what can happen when greed turns to fear - literally overnight. The worst of this resulted from fraudulent activities leading to bitcoin wallets being hacked and trading suspended on some exchanges. Those who bought the futures contracts when they launched will be nursing significant losses.
It is, however, a wake-up call for us all to the extent that, when a market correction comes, it will be sudden and savage as real fear returns. Any investor who is not prepared to remain invested for the longer term and needs to crystallise value within the next couple of years should be very careful indeed and consider a staggered programme of crystallisation rather than continuing to ride the wave in anticipation of perfect timing. Arguably, the longer the bull market runs, the more savage the shock when it ends.
Most likely, any correction will be greeted with calls of it being ‘a buying opportunity' and a short-term bounce will be highly likely. What is key is the catalyst, which will likely be analysed and quantified and discounted - which is what happened initially with the great financial crash, and is almost a certainty given the events that were discounted in 2017.
For now, the bull market continues and all is rosy but be prepared for this to end at some point. When that occurs, it will be vital for advisers and their clients to consider their objectives, their duration and whether they really have the stomach to stay invested or should sit on the side-lines for a while, ignoring the supposed ‘buying opportunity'.
When long-term investing and short-term speculating become intertwined, it is important to determine which camp you are in and have a pre-prepared strategy in place to diffuse the temptation to speculate (buy) or panic (sell). Rarely do either of these kneejerk reactions end well
Guy Stephens is technical investment director at Rowan Dartington
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