GPS TOPIC “Brexit”: Only a Symptom of a Profound ... · Sources: James Davies, Rodrigo Lluberas and Anthony Shorrocks, Credit Suisse Global Wealth Databook 2015 Investment Insight

“Brexit”: Only a Symptom of a Profound Transformation?

With a majority of Britons voting to exit (“Brexit”) from the European Union, attention now turns to the ramifications of this historic rejection of the status quo. Much has

been written regarding the potential effects of Britain’s exit on the U.K., the eurozone and the U.S., and while we do not wish to rehash that, we have summarized some of the considerations for investors.

June 2016 (Updated 6/24/16)

In This Issue:n Why Has the Idea of

a Brexit Gained So Much Momentum?

n Broken Promises?

n Will These Uncertainty-Creating Dislocations Continue?

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The Winners and Losers of Brexit

Winners Losers

� Uncertainty

� Volatility

� Buying opportunity on exit

� Unskilled labor

� The U.S. dollar (USD)

� Safe havens

� Inflation

� Other countries considering an exit

� Britain’s coffers (£350 million per week goes to the E.U.)

� British citizens’ sovereignty

� Britain’s gross domestic product (GDP)

� Britain as global business hub

� High paying jobs, especially banking

� The City of London

� Small and mid-cap companies in the U.K.

� U.K.’s university system

� U.K.’s position in Europe

� U.K.’s property market

While there will be great debate about the future impact of the Brexit over the coming months and the consequences for the E.U., Britain and the rest of the world, we think it is equally important to focus on the deeper questions that may have brought us to a crossroads where the British people have selected this option:

� First, why has Brexit been under such consideration when most investment and financial professionals view the end result as having negative consequences for Britain?

� Second, should we expect these types of uncertainty-creating dislocations to continue?

Investment Insight n June 2016 n Page 2

Why Did the Brexit Prevail at the Polls?It is easy to blame the influx of migrants to Great Britain due to conflicts in the Middle East. It is equally simple to suggest that the discussion on immigration has been elevated to be a reaction to the potential for increased violence in Great Britain that might mirror the attacks in Paris and Brussels. An equally satisfying conclusion would be the most political one: that the opposition party grabbed hold of the low-hanging fruit of appealing to citizens’ concerns that employment and income were negatively affected by E.U. trade policies. One of the most appealing commonalities of these answers is that they allow people to consider them in a local, and therefore limited, context. These explanations are not only simple, but are contained and constrained in their impact and effect. There is evidence, however, that the circumstances surrounding the Brexit seem to have much deeper and more global context as we enter the second half of 2016.

There are numerous other examples of disaffection that have substantially changed the landscape across the globe: Scotland’s consideration of independence, the new political regime in a beleaguered Greece, the rise of the National Front party in France, the rise of former President Viktor Yanukovych in Ukraine, the overthrow of former President Hosni Mubarak in Egypt and multiple populist-based changes in South America. Although in each case there were local reasons for the rise of each idea or leader, the dramatic changes in actual and forecast economic growth, including those shown in the graph below, were clearly an influential factor.

IMF World Real GDP Growth Forecast, 2010-2020

5.5%

5.0%

4.5%

4.0%

3.5%

3.0%

2.5%2010 2011 2012 2013 2014

Forecast Sep-2011 Forecast Oct-2012 Forecast Oct-2013 Forecast Oct-2014

Forecast Oct-2015 Forecast Apr-2016 Actual Growth

2015 2016 2017 2018 2019 2020 2021

Source: International Monetary Fund (IMF) World Economic Outlook Database

In sum, while the global recovery may be more or less robust in different parts of the world, there is an almost universal reality that a large proportion of the world’s people have not returned to the same level of prosperity or living standards they enjoyed prior to the global financial crisis. The continuing decline in growth expectations is disappointing and dissatisfying. In addition, an examination of changes in both wealth and the distribution of wealth only exacerbate the perspective that many have been left behind while others have profited.


Broken Promises?Importantly, the status quo is not the implied promise sought by most: generational improvement in those measures. It may be of value to consider these circumstances from the perspective of the citizens of Europe and the U.K., from the emerging world and from the U.S. The following hypothetical statement may well represent the lens through which the majority of the globe’s populace views the last decade:

We are told that new agreements regarding trade and opening borders should enhance prosperity as the global economy takes hold and goods, services and employment become less expensive for all. Easy money, via low rates and eased lending standards, allows people to reap today the long-term rewards of these favorable developments. Residential real estate values climb unceasingly and, encouraged by government and the financial system, we jump on board the bandwagon of home and second home ownership.

Then the bubble of debt bursts, due, so the reports say, to the greed and excess of bankers and, by association, the politicians that allowed these characters to profit without controls. Now, eight years post the decline, we are informed that we simply should expect less in what is called the new low-growth normal.

The new normal is a world where, while jobs may be created, many of us are systematically underemployed.

The new normal is a world where savings earn virtually nothing, borrowing, while inexpensive, is difficult, and the memory of an underwater house is still fresh.

The new normal is one where corporate profits appear robust, but those dollars are spent on share buybacks or dividends to wealthy shareholders — not higher incomes or employment for us.

The new normal is one where inflation is, we are informed, subdued, but prices for medical care, rent and other basic needs continue to rise without pause or reason.

Finally, the new normal is one where college debt, accepted in view of the expectations of high-paying jobs, has become a burden that can take decades to eliminate at the lower levels of income actually experienced.

Global Distribution of Wealth

Number of Adults (Percent of World Population)

Wealth Range USD

Total Wealth USD (Percent of World)

3,386 million (71%) <$10,000 $7.4 trillion (3.0%)

1,003 million (21%) $10,000-$100,000 $31.3 trillion (12.5%)

349 million (7.4%) $100,000-$1 million $98.5 trillion (39.4%)

34 million (0.7%) >$1 million $112.9 trillion (45.2%)

Sources: James Davies, Rodrigo Lluberas and Anthony Shorrocks, Credit Suisse Global Wealth Databook 2015


This same disaffection, if or when it was experienced 20-plus years ago, might have manifested itself very locally via a labor action or voting a congressional representative or governor out of office. Today, with a populace increasingly connected outside of traditional channels of governments and the media, this deeply unsatisfying story has created an undercurrent of rejection of the status quo that has surprised observers of the socioeconomic fabric in many regions of the world. Blogging, tweeting and other forms of social media enable a virtually instantaneous mechanism to communicate and reinforce dissatisfaction and dissent that seems invisible to polls and politicians. These same forms of connectivity can also be effectively used to increase awareness of specific issues, raise campaign contributions or comment on virtually any topic without editing or fact checking. Unlike the economic new normal, this influence appears to be a certainty and is perhaps more appropriately termed the “connectivity revolution.” This revolution is impacting many aspects of the human condition in a highly positive way. Scientists and researchers, for example, are able to share simultaneously their problems and possible solutions with disparate teams across the planet, providing a virtual global chalkboard of formulas and genetic diagrams. Engineers can build robotic parts in India and literally fax them for printing in Tokyo or Toronto. Fledgling ventures can raise capital rapidly and with broad investor participation through avenues such as crowd funding. An alternative currency (Bitcoin) emerges that may be the way to transcend traditional cross-border transactions. While this is a wildly democratic revolution with far-reaching and still-emerging consequences, there are, of course, darker sides to this story, including cybercrime and the rise of terrorist networks.

It is no surprise that this connectivity revolution would profoundly affect the political world. Intersecting an economic condition — the widespread stagnation in improving living standards — with this connectivity creates an environment where there can be rapid, and at times seemingly inexplicable, changes in perspective regarding the status quo. It may not be that polling does not accurately reach the populace or represent its current view, but rather that this view changes so quickly that polls become unrepresentative at an accelerated pace. In short, volatility may not only be a capital market phenomenon but also a social and political one. Perhaps, however, as with the classic question of the chicken or the egg, the latter has contributed to the former?

Interestingly, another related element of this phenomenon pertains to changing demographics and the acceptance or use of social media. The coming “changing of the guard” as the millennial generation begins to ascend to more powerful roles in business and politics is accompanied by the diminution of the role and dominance of the baby boomers. This effect is magnified given the ascending generation that grew up with the internet and instant communication is at the core of the connectivity revolution. Of great import is the reality that this same cohort is the one that carries the burden of college debt, aspires to greater levels of productive employment and, yet, has inherited a world of slow growth in economic terms, but rapid growth in average global temperatures.

Will These Uncertainty-Creating Dislocations Continue?The aspirational response to the volatility of a millennial-connectivity-driven change in the world’s inner workings would be to remind readers that many of the currently “in charge” boomers were formerly of the “peace-and-love” generation that wore flowers in their hair to accent tie-dye shirts and that this, too, ultimately passed. While this may have been true and could occur again, relying upon hope or the past being prologue seems inadequate as a response. Leaving the analysis of harnessing the connectivity revolution to others in a more relevant field, our goal is to provide assessments that may be of aid to investors operating in the face of this new era.

“ With a populace increasingly connected outside of traditional channels of governments and the media, this deeply unsatisfying story has created an undercurrent of rejection of the status quo that has surprised observers of the socioeconomic fabric in many regions of the world.”


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It is our view that those proclaiming a new economic normal arising from a myriad of factors related to productivity slowdowns, the inability of central banks to successfully stimulate spending and inflation, and declining workforces in the developed world, are missing a bit of the point. The world, and society in general, is undergoing a profound transformation — a generational change of dramatic proportions. While this will certainly affect capital markets and economies, and do so differentially from region to region, the more important influences may relate to the ways in which information is channeled into decision-making and, ultimately, results. These changes, leaps if you will, occur fairly infrequently and generally create dislocations and volatility, particularly as timing and magnitude are difficult to predict. Recall the early days of the rise of the boomers, which occurred largely from the late ’70s to ’80s — a period of great volatility and economic dislocation that came after a market meltdown (1973-74) and before a period of economic growth and stability (the ’90s). Yet, if the past is to be our guide, in seeming chaos, there is order, and it is often necessary to break things down in order to rebuild.

Artificial intelligence, 3D printing, bioengineering, bioprinting, gene therapy, vertical farming, fusion power and the Internet of things — these are not hoped-for advancements, they are technologies on the verge. If, as some futurists suggest, on the topic of technological transformation, we are truly only in the third inning of the nine-inning game, then leaving the stadium when the team falls behind in the first two is a poor strategy.

We also know that when most predictors of future economic activity argue between the binary options of low growth or slipping into recession, as is the case today, the third option, an economic resurgence, is often discounted excessively. If, to place the conclusion most clearly, the “markets” believe the alternatives are only the first two, then placing at least some wager on the third outcome may pay off handsomely. Forecasting the impact of the Brexit on markets over the next several years requires consideration of many unknowns. Will other countries in the E.U. hold referendums? What will the Brexit look like in terms of trade agreements and negotiations? Will Britain slip into recession? How will central banks react? Wagering on any of the short-term market responses to these factors is, at best, a difficult task. Investing for the long term on the ability of humankind to innovate and grow seems a much surer thing. n

“ The world, and society in general, is undergoing a profound transformation — a generational change of dramatic proportions.”

Copyright © 2016 by The Segal Group, Inc. All rights reserved.

Segal Rogerscasey provides consulting advice on asset allocation, investment strategy, manager searches, performance measurement and related issues. The information and opinions herein provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. Investment Insight and the data and analysis herein is intended for general education only and not as investment advice. It is not intended for use as a basis for investment decisions, nor should it be construed as advice designed to meet the needs of any particular investor. Please contact Segal Rogerscasey or another qualified investment professional for advice regarding the evaluation of any specific information, opinion, advice or other content. Of course, on all matters involving legal interpretations and regulatory issues, plan sponsors should consult legal counsel.

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About the Author Tim Barron is the Chief Investment Officer of Segal Rogerscasey, where he manages the firm’s Research Department and oversees all investment activities. He has more than 30 years of experience in the investment industry. Mr. Barron also chairs Segal Rogerscasey’s Investment Committee and is on the Governing Committee of the Global Investment Research Alliance.

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GPS TOPIC “Brexit”: Only a Symptom of a Profound ... · Sources: James Davies, Rodrigo Lluberas and Anthony Shorrocks, Credit Suisse Global Wealth Databook 2015 Investment Insight