European Secession Votes and Market Implications: Scotland

Stuart QuintStuart P. Quint, CFA, Senior Investment Manager and International Strategist

This first blog in a two-part series will examine the Scottish secession vote coming in September and the potential implications for financial markets. The second blog will delve into the Catalan vote in November.

“There is the real possibility of one or several national divorces being initiated in Western Europe in 2014,” opines Nicholas Siegel, program officer at the Transatlantic Academy, a U.S.-European think-tank based in Washington.[1]

Secession votes will be held in the UK in September over the future of Scotland and in Spain in November over the future of Catalunya. It appears unlikely that either will result in a real separation of the regions from these nations. However, financial markets should still monitor the progress of these votes. Markets appear to discount a rejection of secession. If voters in one of these regions were to vote for secession, that could trigger near-term volatility. Regardless, these votes highlight fragility in the fabric of the European Union that warrants monitoring.

Voters in Scotland will elect whether to remain a part of the United Kingdom or to secede and claim independence. A “Yes” vote would lead to binding negotiations between the Scottish and UK Governments for eventual secession. Recent polls suggest pro-independence voters will not succeed as a plurality of voters leans against independence.[2]

Quint_SecessionScotland_8.19.14In the event of a vote for independence, complications both for the UK and Scotland could ensue. The size of the economy and population of Scotland is less than 10% of the UK; yet, these statistics conceal a few hurdles. Much of the energy produced within the UK falls within Scottish jurisdiction. Many UK financial services companies are based in Scotland (though the majority of their revenues derive from outside Scotland). Moreover, the Bank of England has stated that Scotland would have to use its own currency instead of the British Pound Sterling.

The costs of independence could bring with them financial turmoil at least for an independent Scotland. However, the UK itself might not go unscathed as the British Pound Sterling is a reserve currency that could lose support. Major corporations, such as Standard Life, could relocate from Scotland back to the UK

Even a “No” vote, though, does not necessarily put an end to the matter. A narrow vote could give way to a second future vote and have repercussions for future votes on the UK remaining in the EU and general elections in 2015. A “No” vote that fails to win overwhelmingly could potentially accelerate the timing of the referendum for whether the UK remains in the EU.

In terms of financial markets, the closest recent comparable is Canada, which experienced two failed referenda regarding the secession of Quebec in 1980 and 1995. In both instances, markets did not underperform global markets leading into and post the referenda. Although markets shrugged off the referenda, over time many large Canadian corporations relocated their headquarters out of Quebec.

[1] “Is Secession the Answer? The Case of Catalonia, Flanders, and Scotland”, December 2, 2013 retrieved on http://knowledge.wharton.upenn.edu/article/secession-answer-case-catalonia-flanders-scotland/ .

[2] Lukyano Mnyanda, “Scots Anti-Independence Camp Gains in Poll amid Pound Doubts”, August 13, 2014, Bloomberg News.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change.

Why and How Will Housing Finance Be Reformed?

QuintStuart Quint, Sr. Investment Manager & International Strategist, Brinker Capital

The downturn in the housing market affected more than just the banks, but also the U.S. taxpayers. Nearly two out of every three dollars of mortgage debt is owned, guaranteed, or insured by agencies of the U.S. Government. The credit risk on the balance sheets of these agencies exposes the U.S. taxpayer to substantial risk in the event of a housing downturn.

The mandate to promote home ownership coupled with sub-optimal policies resulted in these agencies taking on excessive credit risk leading up to the 2008 financial crisis. Substantial credit losses from declines in home prices damaged the balance sheets of government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. These companies were effectively nationalized during the 2008 crisis. The U.S. Federal Government was compelled to intervene by making their debt an explicit guarantee backed by the full faith and credit of the U.S. taxpayer.  While private capital withdrew from the market, the Federal Housing Administration (FHA) expanded its mortgage insurance program, especially for first-time home buyers, in the depth of the 2008 crisis. Arguably, it might have prevented the housing crisis from getting worse, but the FHA has also been saddled with credit losses and is gradually reducing its participation in the market.

11.08.13_Quint_Housing_2Rare consensus within Washington exists for promoting housing-finance reform, though details on how to implement reform vary. There is little dissension for reducing the role of the Federal Government in the housing market and thus the liability of the U.S. taxpayer. The common vision is to shift the agencies’ role toward being a lender of last resort and reducing credit exposure to last-in catastrophic exposure. Private capital should be the first line of defense in the event of another housing downturn. Policy emphasis would also change from promoting home ownership for all, to attempting to facilitate financing for home owners and renters via financing of new apartment construction.

Difference among various parties pertains to the speed and extent that this transition should occur. Some advocate an immediate unwinding of the federal agencies, though this proposal appears to have little support from majorities in either party. A more gradual unwinding, which to some extent is already occurring, appears more likely.  Agencies would cease to hold mortgages on their balance sheets while retaining their role as credit guarantors for third-party investors in exchange for a fee.

11.08.13_Quint_Housing_2_2The Senate Banking Committee hopes to issue a bill on housing reform by the end of 2013.  Timing for deliberation by both houses of Congress is tricky, but it does appear that bipartisan support for the general parameters of housing reform exists. If done in a responsible, gradual manner, housing reform could ultimately reduce risk to the U.S. taxpayer and perhaps lessen the risk of another housing collapse. However, a hasty and disorderly exit of the agencies from the mortgage market could end up restricting the flow of capital, and thus the pace of recovery in the housing market.

Why Care About Housing Reform

QuintStuart Quint, Sr. Investment Manager & International Strategist, Brinker Capital

Housing is a major component of the U.S. economy and the largest source of wealth for many Americans. Despite the recent rebound, home prices in the U.S. have declined a cumulative -16% since 2006. That masks significant declines in Sunbelt markets hit by the housing bubble collapse (FL -37%, AZ -32%, CA -26%, NV -45%).
(Freddie Mac. September 2013)

Roughly 50% of the stock of housing in the U.S. is financed by mortgage debt. Consequently, the availability and cost of mortgage debt has a direct relationship on the value of housing. Indeed, the 2008 financial crisis exacerbated the downturn in housing as the financial system had sharply cut mortgage credit. The downturn in home prices also damaged consumer confidence for the two-thirds of Americans who owned their home. Many homeowners saw their savings reduced and consequently cut back on their consumption. Additionally, the housing downturn left nearly one out of five Americans underwater on their mortgage debt, (i.e. the resale value of their home in the current market would be less than the mortgage debt they owed). This resulted in higher credit losses for banks, which in turn reduced credit availability across the board.

One reason for sub-par economic growth following the 2008 financial crisis stems from the sub-par recovery in housing. Housing accounts for one out of every six dollars of economic output. (National Association of Home Builders)

9.27.13_QuintAdditionally, the housing downturn has impacted the job market. Approximately 2.5 million lost jobs between 2006 and 2013 were lost because of the housing downturn. Residential construction accounts for 1.5 million jobs including the financial sector and real estate. Housing-related employment amounts to as many as one out of every twelve jobs in the U.S. economy. (Bureau of Labor Statistics. September 6 and The Bipartisan Policy Center)

The issue of how to finance the largest asset for many Americans is of critical importance to future growth prospects for the U.S. economy.

Japan: The Sun Also Rises?

QuintStuart P. Quint, CFA, Brinker Capital

This is part two of a two-part blog series. Click here to view part one.

What are the signposts?

Japan also might be recognizing its opportunity for major change out of years of frustration with both voters and the political establishment.  Current Prime Minister Shinzo Abe assumed office in December 2012 on a platform of promoting economic growth with the use of “three arrows”: monetary, fiscal, and structural economic reform.  So far, he has won positive reviews on the “first arrow”.   Naming a new head of the Bank of Japan with support from both ruling and opposition parties has resulted in an aggressive acceleration of quantitative easing in Japan.  The goal is to change price expectations from deflation to inflation, and thus improve prospects for savings, investment, and economic growth.  Major companies also gave employees small positive wage increases for the first time in many years.  Consumer sentiment and financial markets thus far have responded positively.

Monetary policy is not enough to solve Japan’s woes.  Structural reform must be tackled, though it will not be easy and could take more time.  On the political front, the government must undertake electoral reform in accordance with a ruling from the Supreme Court that could potentially rebalance voting power to younger, urban voters who benefit from more reform.  The question is whether leaders on both sides have the political will to implement a real reform.  If not, Prime Minister Abe could lose approval and momentum to reform.

shutterstock_17785696Additional structural reforms include trade, energy, tax, health care, and agriculture.  Agriculture is key not only to the economy, but also to national security.  As an example, the average age of the Japanese farmer is around the mid-sixties.  Very few large farms with economies of scale exist.  The acreage of farmland in Japan is also declining.  Japan is vulnerable to rising food prices, particularly if other countries restrict exports, such as what occurred several years ago when rice prices spiked.

Japan: The Sun Also Rises?

QuintStuart P. Quint, CFA, Brinker Capital

This is part one of a two-part blog series.

2013 has started out with a bang for the S&P 500, which has outpaced virtually all major developed world markets.  Yet there is one major developed market that has kept pace: the Japanese Nikkei.  As of April 9, the Nikkei has risen +11% in U.S. Dollar terms.  Is the sun also rising in Japan, or are we seeing yet another false dawn?

Why does it matter?

Japan is the third largest economy in the world.  It has been mired in decades of stagnation: tepid economic growth, deflation, aging population, and high fiscal debt and deficits.  These challenges are compounded by a historically strong currency, which has pressured corporate profit margins, and a dysfunctional political system.  As an example, Japan has had seven prime ministers in the last seven years.  Yet in spite of its problems, Japan still retains some strengths, including world class companies and high wealth.  Additionally, the Japanese banking system held up well in the midst of the 2008 crisis.

Japan is the banker to the rest of the world.  If Japan suffers further problems, the rest of us eventually suffer.  For example, Japan is the second largest foreign holder of U.S. Treasury bonds.  Japanese companies continue to buy assets overseas.  If Japan were to curb its interest in foreign diversification, that could have negative ripple effects not just in Japan but even in our market and elsewhere.

JapanFinally, Japan poses a fascinating and relevant case study for the rest of the developed world.  How does a mature economy with an aging demographic and indebted economy solve its problems?  Or is it doomed to ultimate decay and/or default?  Japan has more experience than the U.S. and Europe in dealing with these problems.  For decades, Japan has experienced several decades of stagnation, a burst real estate bubble, and deflation.  Expectations have risen that Japan is making serious efforts to begin resolving these issues with the election of Prime Minister Shinzo Abe.  If progress is made, it could be a blueprint for how we in the U.S. might deal with our issues.  If Japan fails, it could mean that our issues will be difficult to resolve without a major economic shock.

Look for Part Two of this blog next week!

An Update on Greece

With the recent headlines coming out of Greece this week, Brinker Capital’s Senior Investment Manager and International Strategist, Stuart Quint, shares a few quick points.

  • Greek elections on June 18 raise the risk of Greek default sooner rather than later, leading to some uncertainty. However, risks of Greece have been known for a while by the markets. The question is whether we see bank deposit runs out of other weaker European economies (Spain, Italy) and into stronger ones.
  • European Central Bank liquidity measures and hopeful, but inconsistent, fiscal progress in Ireland, Portugal, and Italy could cushion the downside and show commitment to keeping the Euro around in the near term.
  • Economic growth and European equities, primarily, are likely to take the pain until we get further clarity on the issues listed above. U.S. equities and other risk assets will also be affected in the near term due to concerns on slower global growth, although the U.S. is less affected by global growth than other markets.