The Investment Connundrum

 

WEEKLY COMMENT 21-05-2015

By Barry Edwards

The Investment Connundrum

The excitement that was generated after the general election surprise result has quietened down and a period of contemplation has begun to allow some time for investment planning. The main subject dominating the headlines is the European Union and the impending reformation that the UK election result has stimulated.

For many business people, the UK referendum is two years away and although it may be brought forwards a little, it is a long time to wait for the decision of the nation if a company is planning to make capital investments to expand their businesses. Nobody can know the state of the world economy that far ahead which means many business leaders will have to make a judgement about where and how much capital to invest if they are going to keep pace with the competition.

Whether you are a manufacturing or service company, the decisions you will be making could be seriously wrong if your economic forecasts for that time are not correct. Because chief executives have an average period of office for about seven or eight years, many will be unwilling to commit to major investment plans in the UK until the result of EU membership is known. Since the other EU members are not expecting any major changes in status, it is likely that many CEO’s will concentrate their efforts on continental Europe until the situation in the UK becomes much clearer.

Many large UK companies have substantial investments in continental Europe and are likely to consider diverting investment that might have been made in the UK. It is logical that if you wish to be certain that any capital investment will make the returns you have forecast then it would be a better bet to invest there especially since the European economy is likely to recover gradually over that timeframe.

The main point here is that although the Conservative majority is positive for business, there are some short term adverse reasons to believe that growth in the UK may be affected by this EU membership dilemma. The UK stock market has not responded very much since the initial recovery on the day after the election and most of that was down to closing short positions some investors opened up if the result was a hung parliament. Consequently, investors are still undecided about the potential prospects for UK PLC which tends to reflect thinking about two years ahead.

The importance of the progress of discussions with other EU member countries does become very relevant for the investment community and the stock markets in the UK and elsewhere will reflect opinions about the likelihood of a successful outcome or not. Most investors would like to see the UK stay in the EU so any suggestion that it might not occur could have a major impact on share values.

Underlying this debate is the possibility that if the UK did vote to come out of the EU, would that encourage other countries to consider doing the same thing, leading to the potential break-up of the union. Because the EU is a massive trading bloc, this could have serious implications for international companies around the world quite apart from changing the political standing of many European countries. Investors have some thinking to do to way up all the possibilities and decide how to respond to this scenario. In my view this is not an easy decision to make and will create diverse opinions during the time before the referendum.

This is not the outcome that many investors are expecting but if the EU discussions take a turn for the worse this could cause a big disruption to stock markets in developed countries since they all have international shareholders owning large chunks of equity in the stock markets. For the moment, most investors are prepared to give the politicians a chance to make the best deal but the consequences if they mess up are not attractive. Personally, I believe that the UK will stay in the EU and there will not be a big change to the world order of things but there is a small chance matters could get out of hand.

It is too early to make a judgement on this subject but professional investors have to form their opinions based on the current facts and act accordingly. During the next few months we will see what the general opinion is as the discussions progress which makes it very difficult to forecast what the stock market will do in the medium term. I do not envy fund managers and the decisions they must make in the coming months.

That’s all for this week, more observations next week.