Economics and investment report: the uncertainty principle

Most of the time, outcomes for investors fall within a fairly narrow range. Things might turn out a little better than we assume, or a bit worse, but we can plan with a reasonable degree of confidence. Occasionally, however, the future looks sharply uncertain, presenting vastly different possibilities with no way of predicting which will prevail. Brexit is one of those moments.

Depending on who you listen to, Britain faces the imminent threat of recession and even civil disorder. Or this might be the beginning of a bounce in investment and confidence, as this period of deep uncertainty finally reaches a resolution. Economic shock or economic rebound—how are we to navigate between these two poles? In fact, there’s also a third option. The uncertainty could rumble on, for example if the government were forced into an early election. And if that election failed to produce a clear outcome? More of the same.

Faced with this extraordinarily tricky scenario, most investors will probably opt to do nothing and let nature take its course. If you choose this approach and things go badly for you, it’s less disastrous than if you bet everything on a particular outcome and get it wrong.

But investors seeking a degree of safety in this scenario would do well to recall one of the lessons of the financial crisis of 2008-09: the government bond market may offer them protection. Back then, many people assumed that as bond yields plummeted and their prices, which move inversely to their yield, shot up, this signalled that a giant bubble was forming. Some bet that prices had to crash. History—at least so far—shows that they were wrong. Government bonds have remained a safe haven for many cautious investors over the past decade and prices have not crashed. These days, you hear far less talk of bubbles in the bond market.

As the uncertainty gripping Britain has intensified, the prices of 10-year UK government bonds have climbed again, indicating very strong demand among buyers looking for safety. Shifting a chunk of money into funds that include longer-dated UK bonds could be a smart way to insulate yourself against shocks. If you want to balance that with some more risk exposure via equity markets, something like a world equities tracker fund will include lots of big international companies less affected by the UK’s “local difficulties.”

UK investors are in for a tricky few months. Those tempted to position themselves decisively for one of the possible outcomes should recall the words of David St Hubbins, from the satirical rockumentary This is Spinal Tap: “It’s such a fine line between stupid and clever.” Investors looking to tread that line could find at least a degree of cushioning in UK government bonds and large global companies, however the dice fall.

Read Duncan Weldon on the looming currency storm