You Have Just 6 Months To Prepare For Turmoil…

I’m usually the last person to warn about potential hazards ahead for the economy or the stock market.
Indeed, among my Motley Fool colleagues I’ve developed a reputation as a ‘perma-bull’ – someone who’s never seen an equity market he didn’t like.
And I don’t really mind.
The stock market tends to go up over the long term, while crashes often mean you can pick up shares on the cheap. Add dividends to the mix, and it’s time in the market that counts, not timing the market.

Also, I’ve noticed the pessimists often sound smart but they’re less often right.
Of course, every now and then some disaster does materialise – a global financial crisis, or the bursting of a bubble like we saw in the late 1990s.
But we forget the many conflicts that flare and fizzle and ultimately don’t matter. Diseases that prove to be less deadly than feared. The debts and deficits that turn into surpluses while the debate rages.
Prophecies of doom tend to pass not with a bang but with a whimper.

A vote for the unknown

If this sounds like I’m getting my cop-outs in early – you’re right.
I’m not certain the UK stock market is headed for the rocks.
Far from it!
But I do see one potential for upset that is being largely ignored.

And that’s the General Election in May 2015.
Now ordinarily I too don’t think it matters too much which party gets elected from an overall stock-market perspective.
Sure, one lot will tax and restrict certain activities more than the other, who in turn might stoke up a boom or deregulate too far.
I’m not avoiding names just to be neutral – each of the main parties has done all that in my lifetime.
But before any party is actually elected, General Elections cause uncertainty, and that’s never good for shares.
I suspect this has already affected some sectors.
Talk of new property taxes and the danger of banks such as Lloyds and RBS being used as political punch bags is hardly a backdrop for a roaring housing market, for example.

You know who

Run-of-the-mill wobbles are not my concern today, however.
No, we need to take a mental trip to Clacton and Rochester & Strood.
You’ll remember they’re where the UK Independence Party, UKIP, recently won its first two seats in Parliament.
Some of you may think UKIP is the best thing since the iPad or Taylor Swift (okay, possibly not quite the demographic but you get my drift).
Others may see Nigel Farage as a Spitting Image puppet made reality.
Hopefully I’ve offended both factions sufficiently there to reassure you that my concern is simply what the rise of UKIP could mean for the UK economy, and our stock market.
And that concern is summed up in a word…

All Greek to me

Remember the Grexit – the Greek Exit from Europe that was mooted at the height of the European Crisis?
Well, we now face a potential Brexit.
That’s not a high-fibre cereal. It’s the UK leaving the European Union.
Perhaps such a move – as advocated by UKIP, of course – is the best thing that could happen for the UK.
Or perhaps it’s national suicide.
As I say, that’s for another pundit and publication.
Today it’s enough to know that the Conservatives have already committed to a referendum on Europe if they win the election.
And it’s not inconceivable the other parties will follow suit if UKIP keeps stealing their votes – just as we saw a rash of last-minute promises in the Scottish Independence campaign.
In my opinion, a strengthening UKIP in the run up to May’s General Election could make the wobbles over Scotland look about as perilous as going around a roundabout twice because you missed the turning.
It would be time to buckle up for turmoil!

What price revolution?

Investors have not got strong constitutions at the best of times.
With the economy only now getting any real momentum, the house-price recovery only just getting going beyond the M25, the banks only just expanding lending again and the deficit barely dented…
…a potential Brexit could see investors run to the hills.
After all, there are plenty of rational reasons to fear an upset if the UK leaves the European Union: 

  • Contracts would need to be re-written.
  • Inward investment could plummet.
  • Financial-services firms – such as US banking giants – could relocate to the mainland.
  • Deals could favour continental companies better placed to serve the European Union.
  • Wealthy foreigners could stop pouring money into London.
  • The nearly 2 million UK citizens living in places such as Spain and France would need new paperwork, as would EU citizens based here.
  • A collapse in immigration could curb GDP growth.

 What would it cost? Figures vary, but for a flavour:

  • The Confederation of British Industry estimates Britain’s EU membership is worth 5% of GDP, or as much as £78 billion.
  • On the other hand, the UK is a net contributor to the EU budget of £8.5-12 billion a year, depending on what you count. (Certainly we pay in more than we directly get back). 
  • However the most important statistics are our trade figures with Europe, our largest trading partner. In September alone we imported £19.2billion worth of goods from EU member states, while exporting £12.5 billion.

Consider that’s nearly £400 billion in trade a year, and you can see why investors in UK companies might wonder what price British business would pay as the form of higher costs and less accessible markets in a Brexit scenario, and then decide to invest elsewhere.
Eventually the UK would sign free-trade agreements, like Switzerland does with Europe and we do with other nations.
However, the short-term disruption could be considerable.
You might argue the upheaval would be acceptable, in the big picture – I’m not making a call on that.
I’m just saying it’s all ample reason for traders to sell first and ask questions later.

Worst-case scenario

Yet even all that isn’t what really concerns me most about a Brexit.
The big risk is things spiralling out of control.
For example, if international capital decided the UK looked just too uncertain for the next year or two, the pound could weaken.
If it did so too quickly – perhaps because our economy was also deteriorating due to the very same kerfuffle – then that could curb our national spending power and cause inflation to soar.
We could see a dire scenario, where the Bank of England is forced to raise interest rates to defend the pound even as the economy falters.
The impact could be horrendous.
Is it likely? I don’t think so, but like everyone else I’ve no idea.
But I don’t think it’s impossible, and I do think the ‘European-isation’ of the General Election makes it plausible.

Time to play away

So personally, I’m hedging my bets. With new investments I’m generally looking for companies with significant earnings – or better yet, assets – overseas, to hopefully offset turbulence at home.
Hopefully the Brexit threat will prove to be just another scare story.
But six months isn’t a long time to be more cautious… just in case.

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Owain owns shares in Lloyds. The Motley Fool does not own any shares mentioned in this article.