RANDY FREDERICK: Nine months after the historic “Brexit” vote in the United Kingdom, the separation process from the European Union has begun. Jeff Kleintop, Schwab’s chief global investment strategist, joins me for the March 29 Schwab Market Snapshot to discuss the invoking of Article 50 and what it might mean for investors. Welcome back, Jeff.
JEFF KLEINTOP: Thanks, Randy. It’s great to be with you.
RANDY: So, Jeff, today, U.K Prime Minister Theresa May announced that Article 50 had been triggered and that she’s expecting a response from the EU by the end of the week. Now, given that this separation process might last as long as two years, how do you see the whole thing playing out?
JEFF: Well, Randy, Article 50 has never been triggered before, so there’s a bit of uncertainty as to how it might evolve. There are definitely risks. For one thing, the Bank of England, the U.K.’s Fed, if you will, is testing—doing a stress test for their banks. They’re worried about how this might affect the financial system globally. They’re looking at what would happen to the banks if you saw a sudden rise in interest rates, inflation and unemployment in an environment of a shrinking economy, shrinking global trade and concerns about high consumer debt level. So all these things are things that could evolve from Brexit. So they won’t know the results of this worst-case scenario until the fourth quarter.
RANDY: Well, now, in the meantime, are there anything—are there any signals or anything out there that you’re seeing that give you reason to believe that this worst-case scenario could actually come to pass?
JEFF: Well, in the real world, we’re already seeing consumers wind down their economic activity. U.K. households have cut back on their borrowing. They’ve also cut back on their spending. We’ve seen real, inflation-adjusted retail sales pull back. They could actually be negative in the first quarter for the first time in three years. So that’s having an impact. Inflation is rising in the U.K. as their currency has fallen. Imports are more expensive now that the pound has cheapened up, by 15% since the Brexit vote. So all these things are having an impact.
You’ll be hearing more about Article 218 now that Article 50 has been invoked. 218 governs the negotiations, and there will be a lot of back-and-forth and give-and-take, and that can create some volatility in the markets, as investors and consumers assess what it might mean going forward.
RANDY: What about for U.S. investors, is there anything that they can do to prepare for all the things that might be happening over the next 24 months or so?
JEFF: Yeah. Well, certainly, a cautious stance on U.K. stocks makes some sense here. The worst-case scenario of a global recession and accompanying financial crisis is far from a sure thing—it doesn’t appear likely. According to the best forecaster I know of this, the U.K. yield curve—which is just the difference between long- and short-term interest rates in the U.K.—the odds of a recession are somewhere around 30 to 40 percent. Well, they’re not zero, but they’re not over 50% either. It’s not a base case. So there’s a chance, but it’s, again, not that base case. So we should watch for changes to that yield curve. The more the difference between short- and long-term rate shrinks—that’s a sign of worry. We want to keep our eye on that. Also, the value of the pound is important, as well. If that were to fall again sharply, it could raise more concerns about inflation and other pressures in the U.K.
The latest polls show that only 29% of U.K. consumers think they’re going to be better off after Brexit. So that means a lot of pessimism and concerns already reflected in their behavior and the markets. That’s a good thing. It means that the risk of a shock, that could cause a financial crisis or recession, is maybe not as high as it might otherwise be if expectations were low. So investors should stay diversified and investing according to their asset allocations. The most reliable indicators are still telling us that it isn’t time for a more defensive posture yet. But we’ll keep an eye on those indicators and keep you informed as time goes on.
RANDY: That sounds like really good advice, Jeff, thank you so much. That’s all the time we have for today.
Listen, if you want to read more from Jeff, you can do that in the International Investing section of Schwab.com. You can follow Jeff on Twitter @JeffreyKleintop, and, of course, you can always follow me on Twitter @RandyAFrederick. We’ll be back again. Until next time, invest wisely. Own your tomorrow.