The Wimbledon Effect Unravels?

Good morning,

“The Wimbledon effect refers to a chiefly British and Japanese analogy (which possibly originated in Japan [1][2]) which compares the tennis fame of the Wimbledon Championships, held at the All England Lawn Tennis and Croquet Club in Wimbledon, London, with the economic success of the United Kingdom’s financial services industries – especially those clustered in the City of London. The point of the analogy is that a national and international institution (the All England Club) can be highly successful despite the lack of strong native competition, as in modern tennis Britain has produced very few Wimbledon champions, with only Ann Haydon Jones, Virginia Wade (both women’s singles), Jonathan Marray (men’s doubles), Andy Murray (men’s singles), John Lloyd, Jeremy Bates, Jo Durie and Jamie Murray (mixed doubles) winning titles in the Open Era.” Wikipedia

Since the results of the referendum were announced in the wee hours of Friday morning many observers are congratulating themselves on the muted impact of the Leave victory on the FTSE100 stock market index. This is not surprising as many of the largest companies domiciled in the UK which comprise this capitalization weighted index are multinational corporations which earnings as reported in sterling benefit from a weaker FX rate. Thus since the close on the day of the referendum the UKX is down 1.93% in GBP, which translates to 9.08% in EUR, and in 11% in USD.

Since any and all news after the referendum seems to be politically charged, some people have seen this market performance as evidence that leaving is no big deal. We believe that when examined more closely and especially when contrasted with the negative news flow on corporate layoffs ahead of the referendum, combined with a slow moving wreck in buy to let residential property and commercial property, the picture will look a bit less rosy. In a universal pandemic of cognitive dissonance experienced financiers and tabloid readers alike point to this index as proof that there is no shock to the system. More worryingly, in an infantile reaction many also say things like European indices are down far more (though not in Euros). Of course they are. We were already heading for another well-advertised round of the crisis without this new blow.

Most of you are by now familiar with the dire solvency situation of the Italian and Portuguese banking systems, as well as that of some German and French banks. Problems with banks are not restricted to the continent though. SBC already announced on June 8 that it is planning to lay off 8,000 staff in the UK in its retail and investment banking operations, this is nearly 17% of UK staff. Globally HSBC is planning to shed 25,000 jobs or just under 10%, but excluding the UK jut 7.8%.

In fact the largest weights in the FTSE , which stock prices have vastly outperformed domestic market geared companies, have the vast majority of their employees outside of the UK. British American Tobacco has 50,000 employees worldwide but just under 2,000 in the UK. Royal Dutch Shell announced on 25 April that it is closing 3 UK offices affecting 1,600 employees, including recently acquired NG’s headquarters in Reading. Shell employs 93,000 people worldwide. Some people will say that a weaker pound may reverse some of these lay-offs or even lead to new hires, we very much doubt this will be the case since sterling is still overvalued on a trade weighted basis in spite of the correction according to both BIS and IMF data.

Other companies included in the index have not fared so well especially banks and home builders with large exposure to the UK economy. Berkeley Group, Barclays, RBS, IAG, Easyjet, Barrat Developments, Taylor Wimpey, or Persimon have been clocked. Many falling nearly 30% in three days in spite of yesterday’s bounce. We find it difficult to believe that the management teams at these companies will accelerate their hiring in the current uncertain environment. These companies have a much larger percentage of their employees in the UK, and from the looks of it some these jobs are at risk.

Higher unemployment combined with lower investment are surely not go unnoticed by HM Revenue when they count the beans. What will the new Chancellor of the Exchequer do then? More austerity? And the Bank of England? Perhaps more GBP depreciation? As we have learned since the temper tantrum, currency regime flexibility alone doesn’t seem to calm contemporary investors, especially in the presence of a decelaration of economic activity combined with a constitutional crisis, and maybe even a general election.

In its most recent review of the UK economy, the IMF points to the record current account deficit as a problem. For 2016, the IMF estimated a current account deficit of 5% of GDP. Some will say that this is self- correcting problem with the weaker pound, and they would be right to some extent yet the inconvenient fact is that the UK’s current deficit’ s composition is somewhat different from other Fragile 6 countries.

The Office for National Statistics web site contains detailed analysis of the Balance of Payments

“In 2015, the UK was a net borrower of £97.3 billion, up from £92.9 billion in 2014. The £4.4 billion increase in net borrowing in 2015 was due to the total trade deficit widening by £2.3 billion and the primary income deficit widening by £1.9 billion.

The widening in the total trade deficit in 2015 was due to exports falling £1.9 billion from 2014 and imports rising slightly (£0.4 billion). The widening in the primary income account deficit in 2015 was due to receipts decreasing by £10.8 billion from 2014, while payments only decreased £8.9 billion from 2014. These decreases were mainly due to decreases in the earnings of UK direct investors abroad and foreign direct investors in the UK.

In 2015, the current account deficit equated to 5.2% of GDP at current market prices, compared with 5.1% in 2014. The deficit in trade in goods and services was equivalent to 2.0% of GDP in 2015, compared with 1.9% in 2014. The primary income deficit equated to 1.9% of GDP in 2015, compared with 1.8% in 2014, and the secondary income deficit equated to 1.3% of GDP in 2015, compared with 1.4% in 2014.”

Thus the UK is borrowing money not to consume but rather to pay non-resident investors dividends and interest, as well as, as Nigel Farage points out, to make payments to the EU included in the secondary account. Somehow the City seems to believe that the rate of reduction of their surplus with the EU in services will be far larger than the gains from the reduction of payments to Brussels. Nothing to worry about though, they are often wrong, right?

Best regards,
Luis

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