The number of economic and capital market commentaries claiming that uncertainty is the only certainty these days is enough to make an investor's eyes roll and stomach turn, and yet this timeworn notion seems particularly apt at the moment.
We've always had the bulls and the bears, but now we have a critical mass of an altogether different category—the perpetually ambivalent. A recent survey coming out of Camp Kotok, an annual gathering of professional economists, revealed a very narrow band of one-year forecasts concerning a number of different asset classes, economic indicators, and monetary policies. The consensus mostly reflected next-year figures not far from where they reside today, which could be construed as a lack of collective conviction about how things will look in the not too distant future.
The U.S. Economic Policy Uncertainty Index has recently hit multi-year highs not seen since the U.S. debt-ceiling crisis of 2011. Moreover, the American Association of Individual Investors (AAII) has recorded neutral sentiment readings at highs not reached for a decade, and Wall Street's sell-side analysts currently have their highest share of neutral recommendations in a half-dozen years-more reflections of the timidity throughout the system.
Typically, higher levels of uncertainty are seen as a response to unsettling geopolitical or macroeconomic developments. On both fronts, there are a number of global undercurrents in the mix that might point to the widespread indecision among consumers and investors throughout many parts of the world. We also think uncertainty is so entrenched that its momentum is feeding on itself, a cyclical pattern that has been reflected in a range of indicators for some time. As long as those in the ambivalent camp continue to restrain their consumption and investment activities, the global economy will continue to suffer from a dearth of aggregate demand.
"Brexit means Brexit," but details are lacking—U.K. recession is likely, regardless
The U.K.'s June 23 referendum result, reflecting a desire to exit the European Union (EU), also known as Brexit, represents a major uncertainty in the Western world. The new British Prime Minister Theresa May has promised that “Brexit means Brexit,” but what that really means remains an open question. Prime Minister May has suggested that Article 50—the legal process a country must initiate to formally withdraw from the EU—is likely to be invoked in early 2017, even though the United Kingdom suffers from a lack of specialists in trade negotiations. The EU has handled U.K. trade negotiations for years, so the country needs to recruit considerable talent before embarking on what will be difficult and protracted proceedings. Once Article 50 is triggered, a two-year window opens, during which the terms of the U.K. exit from the EU will be negotiated. In our view, as long as the country's relationship with the EU remains unclear, many investors are likely to avoid committing capital to the United Kingdom until they have a better sense of the new regulatory environment that they'll be facing. The U.K.'s current account deficit will likely shrink as consumption—and therefore imports—falls, but we don't view that as sustainable. Over the medium term, we think a fall in investment will hinder exports, just as it did in the peripheral eurozone countries over the last six or so years. We forecast a mild recession in the United Kingdom in 2017.
Will other EU member states follow the United Kingdom?
Minutes after the U.K.'s Vote Leave campaign's victory was called, populist Dutch politician Geert Wilders demanded a referendum on the Netherland's EU membership. Shortly thereafter, Marine Le Pen, leader of the National Front, called for an EU referendum in France. French Minister of Economy Emmanuel Macron has even floated the idea of a pan-European EU referendum; Sinn Fein, an Irish republican political party, has already demanded an Irish unification vote. While these voices of dissent are finding resonance in certain circles, core support for the EU has actually risen in France, Germany, and Spain, but we do not expect this sense of unity to be sustained indefinitely with pressures continuing to mount. Solidarity has been irreparably eroded in the region, first by the debt crisis and more recently by the refugee crisis. If other European countries ultimately choose to leave the EU, the risk of contagion throughout the global economy would be significantly amplified.
U.S. presidential campaign reflects a divisiveness, leaving questions unanswered
In addition to a busy election schedule in Europe over the next year or so, the weeks leading up to and following the U.S. general election cycle will continue to generate uncertainty throughout the world. Regardless of who wins, it's unclear what most major policy initiatives in the United States will look like. Both Donald Trump and Hillary Clinton have spoken out in favor of infrastructure spending, so we can expect some fiscal stimulus under the next administration. If either candidate is able to implement the trade policies that they have espoused during the campaign, we can expect an uptick in the degree of protectionism. While Mrs. Clinton has come out against certain trade agreements, such as the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership, Mr. Trump has expressed support for a more extensive brand of protectionism that includes new tariffs. Trade is one of the few policies over which a U.S. president can unilaterally assert executive authority, and if Mr. Trump is elected and manages to push through all of the trade-related policies he seems to support, we expect this would create a major headwind for the U.S. economy. Beyond trade and defense, the ability of either candidate to implement policy depends on which party wins control of the House and the Senate; the former appears likely to go to the Republicans, but the latter is seemingly up for grabs.