Our Opinion: 2018

Invest for Brexit – whatever the outcome

After more than two years of talks, Prime Minister Theresa May has agreed a draft withdrawal agreement with the European Union (EU). The UK is on its way out of the EU. Brexit is assured. Or is it?

Her chances of getting her withdrawal agreement through parliament in its present form appear non-existent – she simply doesn’t have the support. If the deal is knocked back when parliament votes on it in early December, there are basically four options left.

Two of the options involve returning to the country for a second opinion. One is to hold another general election, the other is to hold a second referendum. Both are fraught with difficulty. They would take time to organise (not least agreeing the question for the referendum), and they would require the backing of MPs. The first point is probably surmountable. Under the terms of Article 50, the UK is set to leave the EU – regardless of where negotiations are – on 29 March next year. But while it would require the assent of all of the other 27 member states, the EU would probably agree to extend this deadline, as either a general election or a second referendum could result in Britain simply voting to “remain”, which the EU would ultimately prefer.

However, the second point is much tougher. For another general election to take place, two-thirds of MPs need to back it. That is a gamble that most Tory MPs will be unwilling to take, particularly as there’s no obvious outcome in which they stand to gain anything. A second referendum might appeal if there is no sign of any sort of agreement in parliament, but it really would be a sign of weakness on the part of the government – and of course, if the public voted anything other than “remain”, then parliament would end up facing the same set of problems again.

So what does that leave? There are really only two options in the likely event of rejection. Either talks continue, or Britain leaves without agreeing a deal.

So what happens if we can’t agree, there’s no extension to Article 50, and Britain leaves the EU with no deal on the table? There are a range of short-term scenarios, but all would have some sort of negative effect in the short term, but the scale depends on exactly how a no deal unfolds. At one end of the spectrum, you have an ‘orderly’ Brexit in which relations between Britain and the EU remain cordial despite the lack of a formal trading agreement. As a result, you could have widespread co-operation on big administrative issues such as aviation, custom checks and visas, with disruption kept to a minimum. In this case, any short-term economic damage would be limited.

What if it’s disorderly? This would probably result in outright recession and a hit to GDP of as much as 3%. The biggest hurdle in the short term is not so much trade tariffs, which average out at around 4%. The real issue is the administrative burden of customs controls. Even although only roughly 3% of non-EU trade is currently subject to documentary checks, and less than 1% to physical inspection, border checks would still take longer, which could cause supply chains to collapse, production of some goods or services to be halted and confidence to plummet. Yet, any period of disruption would be short-lived. The weak pound would hit disposable incomes, but make British exports cheaper. Meanwhile, there would be official support – the chancellor would increase public spending, and the Bank of England would likely cut interest rates.

That said, any rebound in economic growth would be more muted if the domestic political situation was still in turmoil, or if a new Labour government were to introduce anti-business and tax-raising measures.

If a deal is done, sterling will almost certainly rally, potentially quite vigorously. That would normally be bad news for UK stocks, but given that surveys suggest that fund managers are extremely “underweight” UK assets right now, they would probably return once the uncertainty has passed. Domestically-focused stocks would probably do particularly well, whereas dollar earners might struggle as the pound rallied. But even in the case of “no deal”, the reality is that British stocks look cheap.

That doesn’t mean that stocks can’t go lower from here – it’s certainly true that we may not have seen the point of maximum pessimism on UK stocks as yet, and you can argue that the current slide in US stocks bodes ill for global markets in general.

However, the FTSE All-Share is now trading on a dividend yield of around 4.4%, which is getting on for the highest it’s been since the financial crisis.

Yesterday, the FTSE 100 fell to its lowest level since December 2016 and European stocks in general suffered their worst one-day fall since the Brexit vote more than two years ago.

This time around, it wasn’t specifically about Brexit – other markets, most notably the German market, are suffering too. In fact, Germany is now in a bear market (having fallen by more than 20% from its most recent high) whereas the UK market is still just in “correction” territory (down by more than 10%), despite enjoying a bit of a bounce this morning.

The FTSE 100 has gone nowhere in almost 20 years. For any investor, that must be tempting.

7th December 2018