Strategy team: Victor Balfour
Brexit is becoming a market concern again: the UK’s transitional period cliff-edge is fast approaching. This is neither a new nor surprising development, but we felt compelled to examine the latest political dispute.
According to media reports, UK and EU negotiating teams remain quite some way apart on a number of topics, including the structure of the agreement, ECJ jurisdiction, fisheries and rules of origin checks amongst others. Gamesmanship is visible on both sides of the channel: the latest skirmish may see the EU take legal action over the UK’s bold – and divisive - plan for its own ‘Internal market Bill’, essentially repudiating the Northern Ireland Protocol within the Withdrawal Agreement.
The Bill may be part of that ongoing gamesmanship. Moreover, it may not get passed – the Conservatives’ near 80-seat majority in the Commons does not extend to the House of Lords.
We also doubt that either side is quite as intransigent as they appear, and a last-minute deal is still possible. 31st December notwithstanding, intervening ‘deadlines’ – EU Council Meetings and Parliamentary sessions - are not immutable, and as recent history has shown, such complex and sensitive negotiations are often not concluded until the 11th hour.
In particular, we doubt that the UK government will accept a ‘no deal’ outcome, thereby reverting to unfavourable WTO terms for goods (and non-existent terms for services), without some behind-the scenes attempt at compromise.
A no deal scenario is - from the viewpoint of business and employment - clearly the worst outcome. But generally, even with a deal, the UK needs to negotiate improved trade deals with the rest of the world simply to compensate for the friction – logistics, duties and uncertainty - being reintroduced as we inevitably trade at worsened terms with our current EU partners. Without a deal, the friction would be considerable.
Undoubtedly, a no deal out come clearly presents a material risk, while any compromise agreement would likely lead to a sigh of relief given the current state of the debate. In gauging such a risk, the key point is that EU/UK trade and direct investment links are more important to the UK than to the EU partners: our exports to them, for example, are a bigger proportion of our total income than their exports to us are of theirs.
That said, for a number of reasons – population growth, legal and cultural contexts, the relative ease of doing business, a flexible labour market, low taxation, clusters of global expertise – we think the damage done even by a WTO outcome would be manageable for the UK economy. And after the much greater trauma of the COVID-19 suppression, it might now be perceived less sharply.
The most visible impact from a no deal outcome is likely through the currency, where the revived risk of a 'hard' Brexit has already had an effect. Sterling has regained some momentum against the euro in recent days, yet with the bilateral rate below 1.10, it is not far off the lows witnessed in early March, and down 7% on a year-to-date basis. (Admittedly, positive developments on the EU recovery fund and the wider federalist agenda have given the euro an independent lift).
We still feel that the pound is likely to rally against most major currencies on a longer-term view: it is competitive, and expectations for relative growth – and relative interest rates – may be too low. Of course, investment conviction regarding currency forecasts is low at the best of times.
UK growth outlook
In terms of risk assets, the UK’s stock market has been underperforming for some time and the pandemic has only accelerated that trend; UK stocks are down nearly a fifth year-to-date whereas global stocks are up 4% (in sterling terms), highlighting the UK’S unpopular sector mix (big weightings in mining and oil; small weightings in technology).
However, the UK market contains many globally-active businesses – not just those resources groups – and their businesses may be little affected by Brexit. Moreover, we build our portfolios with a global viewpoint to begin with, and most of our chosen companies are capitalised outside the UK: the UK is just a small part of the global economy. And if the pound does weaken further for a while, that will provide another buffer for UK portfolios. In the immediate aftermath of the referendum, sterling’s weakness helped reduce damage to portfolios, and it may yet do so again if a last-minute compromise fails.
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