What’s Next for Global Investors?
So what does this all mean for global investors?
UK equities have declined over 14% this year, significantly underperforming their Developed Market peers in Europe, Asia, and North America, reflecting the country’s heightened risks. Further, the British pound has been under pressure against the US dollar and the Euro this year as well, as ongoing negotiations have spooked FX traders out of the currency. Given the current state of the UK economy, a failure to establish a Brexit deal would deliver a severe blow to the fledgling UK economy. However, in recent weeks, it seems that some of these risks have been priced in to these markets already, including the expectation that the BOE may venture into negative interest rate territory in the event that such a measure is needed to support the country’s economic recovery. Therefore, with such risks priced into the markets already, a last minute deal may give a significant boost to UK assets, as well as improve overall market sentiment and confidence in the UK economy.
We believe that in the event that a last minute deal is reached, we could see the following reaction in UK asset markets:
- A rise in the British Pound against the Euro and US Dollar, as prospects for negative yields fade;
- A rally in UK equities, as a key economic risk is removed; and,
- Gains in UK financial stocks, due to a reduced risk of negative yields and a smaller marketplace for their products and services.
As we enter the final chapter of the “Brexit” story, make no mistake that investment risk for UK assets has increased in recent weeks. Nonetheless, UK assets could offer potential opportunities for investors who are willing to take the plunge, and bet on cooler heads prevailing and reaching a deal.
“Deal or No Deal?”: Brexit Risks & Opportunities for Investors
As the clock ticks down to when the UK must leave the EU, the risk of a “No Deal” Brexit and its potential fallout is still a risk hovering over the UK economy. Despite this threat, UK assets could hold some surprises for investors if a deal can be reached.
“Deal or No Deal?” – No Deal Brexit Still on the Table
The risk of a hard “No Deal” Brexit rose in recent months weighing on UK assets, including the British Pound and UK Equities, as well as pushing UK monetary policy rate expectations into negative territory for the first time. But, as Brexit moves into its final stages, there may be potential opportunity for investors willing to give UK assets a second look.
UK Equities (in blue) have lagged their Developed Market peers since the March 2020 rebound, as Brexit talks continue to weigh on the country.
Possible Brexit Scenarios for the UK and EU
The current impasse is due to UK legislation that would alter key elements of the Brexit Withdrawal Agreement, including Northern Ireland trade and subsidies that would apply, if a free trade deal is not reached between the EU and the UK. This impasse threatens to derail trade talks that must be finalized before January 2021.
Given this situation, there are three possible scenarios that could play out between now and January 2021:
The Three Scenarios
1. No Brexit: If the UK cannot decide on a (new) border between the EU and itself, either between Great Britain and Northern Ireland, or between Ireland and Northern Ireland, then the UK will not be able to leave the EU’s Single Market and Customs Union.
2. The Brexit Withdrawal Agreement: If the UK leaves the EU’s Single Market and Customs Union, and does not want to establish a border between Ireland (which is still part of the EU) and Northern Ireland (which is still part of the UK), then a border between Great Britain and Northern Ireland must be established.
3. Violation of the Good Friday Agreement: If the UK leaves the EU’s Single Market and Customs Union, and does not want to establish a border between Northern Ireland and Great Britain, then there must be a border established between Ireland and Northern Ireland, violating the Good Friday Agreement, which specifies that the island can not be divided.
What’s Next for Kingdom?
If the EU and UK arrive at a trade agreement, then UK legislation, and the subsequent backstop issue it created, does not apply. Despite the difficulties at the moment, we believe there is still time for a compromise on the main issues preventing the EU and UK from establishing a trade deal. Although there is a possibility that the UK legislation may stall in the House of Lords, whether it be pulled or defeated, it is still holding up Brexit negotiations. Nonetheless, we expect a resolution at the last minute. At that time, after having pursued (and exhausted) all other avenues, UK Prime Minister Boris Johnson may accept a deal that is close to the present EU proposals, as he did when he signed the Withdrawal Agreement in October 2019.
In terms of monetary policy, as a result of the ongoing negotiations, the Bank of England (“BOE”) is currently in a tough spot. Despite improving economic data, the BOE is facing increased risks of a “No Deal” Brexit, as well as a sharp rise in new daily COVID-19 cases and new lockdown measures. Furthermore, markets have moved to price in a rate cut in the coming months, putting the reference rate in negative territory from the current rate of ~8bp.
What’s Next for Global Investors?
So what does this all mean for global investors?
UK equities have declined over 14% this year, significantly underperforming their Developed Market peers in Europe, Asia, and North America, reflecting the country’s heightened risks. Further, the British pound has been under pressure against the US dollar and the Euro this year as well, as ongoing negotiations have spooked FX traders out of the currency. Given the current state of the UK economy, a failure to establish a Brexit deal would deliver a severe blow to the fledgling UK economy. However, in recent weeks, it seems that some of these risks have been priced in to these markets already, including the expectation that the BOE may venture into negative interest rate territory in the event that such a measure is needed to support the country’s economic recovery. Therefore, with such risks priced into the markets already, a last minute deal may give a significant boost to UK assets, as well as improve overall market sentiment and confidence in the UK economy.
We believe that in the event that a last minute deal is reached, we could see the following reaction in UK asset markets:
As we enter the final chapter of the “Brexit” story, make no mistake that investment risk for UK assets has increased in recent weeks. Nonetheless, UK assets could offer potential opportunities for investors who are willing to take the plunge, and bet on cooler heads prevailing and reaching a deal.
Related Market Commentary
“From the Outside Looking in”: The 2020 US Presidential Election and Europe
Related Portfolio Solutions
For clients who are interested in our recommended countries and regions, please refer to our Country and Regional Portfolio Solutions.
For clients who are interested in our recommended sector and industry, please refer to our Sector and Industry Portfolio Solutions.
For clients who are interested in our recommended fixed income recommendations, please refer to our Fortress Global Credit Opportunity Portfolio™.
For clients who are interested in our recommended real estate recommendations, please refer to our High Castle Global Real Estate Portfolio™.
© 2020 Economics Global Inc.
Content Disclaimer
Any views expressed here are those of Economics Global Inc. as of the date of this publication, are based on available information, and are subject to change without notice. This document does not constitute investment advice.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.