Brexit is a 'distraction' from the real problems facing the world economy

Distraction basketballEthan Miller/Getty ImagesUNLV Rebels fans try to distract Trey Kell #12 of the San Diego State Aztecs as he shoots a free throw during a game at the Thomas & Mack Center on January 30, 2016 in Las Vegas, Nevada.

If you’re worried about Brexit, you shouldn’t be. Not because it wouldn’t impact markets short-term, but because there are bigger troubles out there for the global economy.

At least that’s the thought of Andrew Lapthorne, head of quantitative strategy at Societe Generale. In a note to clients Monday, Lapthorne said there are much worse issues in the economy than Thursday’s Brexit vote and other political events.

“Whatever the outcome of the Brexit vote this week investors will still be facing the prospect of negative rates and negative yields on a huge range of bonds, massive corporate leverage with worryingly rising delinquencies and of course expensive equity markets and falling profits,” wrote Lapthorne.

“To that extent these political events are a distraction from the main event, weak global economic growth and perverse asset markets.”

While there will likely be a market reaction to the Brexit outcome, Lapthorne believes that the decision by the United Kingdom to stay in or leave the European Union is not material to the issues latent in the economy.

As a quick refresher, Brexit is in reference to the decision before voters in the UK on Thursday on whether to remain a member of the EU. If the country decides to leave, most economic analysts predict that the move would have slew of negative economic consequences. Staying in maintains, as Lapthorne puts it, the “status quo” of the continent.

Lapthorne has long been concerned over the debt levels of corporations, the falling returns for investors, declining profitability, and high price to earnings ratios. Add up all of these issues and the vote is just a blip on the radar for investors.

Lapthorne uses the UK referendum as an example of how these votes mean little to the fundamentals of the markets. From the note (emphasis ours):

“The market will most probably rally as it is doing today if Brexit is rejected, but rally to where? We have already highlighted the excessive leverage and payout ratios in the UK, but these are not the only problems. On a disaggregated basis, median valuations are at the upper end of historical estimates, profitability whether measured on an [return of equity], [return on assets] or [return on invested capital] basis has rarely been this weak outside of an economic slump, and these figures do not materially change whether the problematic commodity and financial sectors are included or not. Brexit or not, the UK equity market hardly looks healthy.

To be fair, the impact of the UK leaving the EU would be significant for the country’s GDP based on most estimates, and the political impact could be wide-ranging.

To Lapthorne, however, these don’t change the structural issues that lie in wait for the markets. The thinking being, it doesn’t matter whether the UK is in the EU or not if corporate debt sudden becomes an issue or heightened P/E ratios get into bubble territory. Either way the vote goes, those problems will hurt investors.

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