Brexit: 10 answers to questions investor may have

We have asked our Technical Manager, Gillian Shirt, to compile a short document providing answers to some of the questions that investors may have as we enter the final six months before Brexit. Whilst not exhaustive we hope it provides a valuable summary.

The UK’s scheduled departure from the EU is fast approaching. Many observers are hopeful for an orderly withdrawal; however, there remain plenty of potential pitfalls between now and Brexit-day. The only near-certainty at present is that the UK will cease to be a full member of the EU on 29 March 2019.

Negotiators are currently working on a “withdrawal agreement”, to be followed by a transition period to run from the end of March 2019 to the end of December 2020. During the transition period negotiations would focus on the permanent future UK/EU relationship, including any potential agreement on trade.

Most aspects of the UK’s EU membership would remain in place until December 2020 under this scenario, including free movement across borders and inclusion within the customs union and single market. However, in the event of no agreement, or a so-called “no deal” Brexit, what happens after 29 March 2019 is uncertain.

1. What are the key dates for investors to watch out for? 

While deadlines for talks are flexible, most commentators believe a withdrawal agreement needs to be in place by the end of 2018 at the latest. This would allow the individual member states enough time to ratify the agreement once the EU and UK leaders have signed off the final text. While the majority of the agreement’s text has been settled upon, there remains some distance between the two sides, particularly around the Irish border. There is the potential for a summit in November and the scheduled meeting in December is widely seen as the last practical date for an agreement to be signed off by EU and UK leaders.

2. In addition to EU member states ratifying the agreement, does UK parliament also need to approve it? 

Yes, UK parliament will vote on the withdrawal agreement. The Conservative government lost its parliamentary majority at last year’s general election and the market is agonising over whether it can rally sufficient support to get an agreement passed. An uncertain UK domestic political situation has also added to market fears that the country may end up with a “no deal” Brexit.

3. What does the withdrawal agreement cover? 

Citizens rights’, the UK’s financial commitments to the EU and the Irish border. Only during the transition period will the details of the permanent future relationship between the UK and EU be negotiated, including trade arrangements. In the event of “no deal”, in extreme circumstances the UK and EU would revert to World Trade Organization (WTO) trade arrangements on 29 March 2019.

4. The type of Brexit we get will have consequences for the UK economy, but how important is the UK economy to the UK stock market? 

For the market overall, less than a third of its revenues are derived from the UK, so what is going on in the rest of the world is often more important. There are sectors that are more exposed to imported goods and/or the UK consumer, where sterling weakness would be a potential negative.

5. What has been the market impact of Brexit to date? 

In the period from mid-2013 through to the end of 2015, the UK economy outperformed the global economy, sterling was strong and UK domestic companies outperformed UK overseas earners. Then, as Brexit fears set in and the UK voted to leave the EU, UK domestics significantly underperformed. Exchange rates were a major driver of this, as the market discounted the beneficial translational impact of weaker sterling for companies with significant overseas earnings.

6. Has Brexit negatively impacted the whole of the UK stock market? 

Yes, investors have indiscriminately shunned UK stocks as a consequence of Brexit, and the market overall has suffered a de-rating. Prior to the EU referendum investors had been prepared to pay approximately 15x the UK stock market’s expected aggregate earnings for the year ahead. Today, this multiple, or “rating” is around 13x, which compares very favourably to the global stock market, trading on approximately 15x expected 2018 aggregate earnings.

7. How might sterling react depending on the possible Brexit outcomes? 

Sterling has been an effective mechanism for either expressing confidence or fear in Brexit and the fate of the UK economy. Sterling is currently trading around $1.30 the majority of economists expect significant downside in a no deal scenario, the average estimate being around $1.10, downside of approximately 15%. In the event of a withdrawal agreement, the average estimate is for the currency to appreciate to approximately $1.40.

8. In the event of a withdrawal agreement how might the UK stock market perform? 

If we did get a withdrawal agreement, there would likely be an upwards movement in sterling and a re-rating of the whole market, particularly benefiting those UK domestics that have been severely de-rated over the last two and a half years. That would include the UK-focused banks, property companies, housebuilders, consumer discretionary areas (general retailers and leisure companies), food retailers and media agencies. Because of the Brexit-related risks the valuations of the UK-focused banks (Lloyds Banking, Royal Bank of Scotland and Barclays) are very attractive versus their EU and international peers.

9. How might a “no deal” Brexit influence UK monetary and fiscal policy? 

In the event of a no deal we would not expect the Bank of England to change interest rates but instead look through the possible negative impact on the economy of sterling weakness and increased inflationary pressures. We could, however, see a repeat of other elements of the central bank’s policy response following the 2016 EU referendum result, when, in addition to cutting base rates to 0.25%, the BoE injected liquidity into the financial system and used forward guidance to reassure the market over the future path of base rates.

10. What would you expect to happen to UK interest rates should there be a withdrawal agreement? 

In that event we are more likely to see a rise in interest rates. The BoE increased base rates in August to 0.75% as it judged the slowdown in the UK economy in the first quarter of 2018 to be temporary, and related to the very cold weather at the beginning of the year. This subsequently transpired to be the case, with preliminary GDP data from the Office for National Statistics revealing growth had bounced back in Q2, albeit, in part, helped by the very warm summer and World Cup.

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