Market Bulletin – A Good Deal Worse? – Monday 19th November 2018

A turbulent Brexit defined the week for the UK: May’s deal divided her Cabinet, jeopardised her leadership and rocked markets. Meanwhile, there were also unnerving economic signs beyond the UK’s shores.

“There are decades where nothing happens; and there are weeks where decades happen.” – Lenin

After a week that could be described as anything but calm, Lenin’s above quote rings true for the UK. Despite feelings that we were finally inching closer to a successful Brexit deal, there were still plenty of twists and turns for Theresa May to navigate. And amid such uncertainty, currency and equity markets unsurprisingly reacted strongly.

Sterling rapidly strengthened as Theresa May delivered first a Brexit deal, followed by Cabinet approval (of sorts) for that deal. Her 585-page draft withdrawal agreement not only stood to deliver a UK exit but also ticked boxes for both sides: not least, sovereignty over UK borders and continued market access, at least for the short term.

However, her optimism was not widely shared by her parliamentary colleagues. Despite a marathon five-hour Cabinet meeting, she quickly faced a wave of ministerial resignations, including the Brexit Secretary, Deputy Brexit Secretary and Northern Ireland Secretary. The following day, the deal was denounced from all sides; as a result, the pound fell 2.5% on Thursday, echoed by domestically focused shares.

A united opposition

The most prominent opposition to May’s deal – shared by both Remainers and Brexiteers alike – was the view that the terms represented the very reverse of ‘taking back control’, by giving an enormous transfer of sovereignty to the European Union – until at least the end of 2020 the UK would have to accept EU rules while rescinding its right to vote on them. During transition the EU would enjoy a range of continued powers in the UK, from blocking mergers to ruling on agricultural culls. Moreover, while a border down the Irish Sea was avoided, Northern Ireland would have to accept closer regulatory alignment with the EU than England, Scotland or Wales.

The DUP, leading Europhiles, Scottish Tories, the Scottish National Party, the Labour leadership, the Liberal Democrats, and the pro-Brexit European Research Group (ERG) all expressed immediate opposition. A no-confidence vote in the Prime Minister could yet be held, although parliament’s vote on the deal may be more dangerous.

Possible outcomes

Although it is still just about conceivable that the Prime Minister’s deal might pass through the UK parliament, last week appears to have significantly widened the range of potential Brexit outcomes.

The alternatives involve some kind of political crisis or turnaround. Theresa May would be forced to resign if she lost a no-confidence vote, but choosing a new leader does little to settle a polarised party that lacks a majority. If parliament then refuses to vote through a no-deal exit from the EU, a general election or second referendum becomes more likely. Given the tone of Brexit rhetoric, neither is likely to be pleasant – and May is banking on this argument when persuading parliament to vote through her deal.

Azad Zangana, Senior European Economist and Strategist at Schroders, commented: “The UK’s negotiating power has been overestimated by many – the EU has dictated the terms of Brexit from the beginning. The deal is largely as we expected, but this is only the beginning…we believe the risk of a no-deal Brexit will focus minds and lead to cross-party support for May’s deal.”

The Brexit effect

Despite Brexit having an impact on much more than just markets, investors still must heed the effects. A weaker sterling is often good for the FTSE 100, since three quarters of the revenues of companies listed on the FTSE 100 are derived from outside the UK – and their revenues therefore go up in sterling terms when the pound declines. However, just because a company derives most of its profits abroad, it does not follow that it will be immune to UK developments, and particularly to short-term sentiment – indeed, the FTSE 100 declined last week, due in part to slippage among financial, property and retail stocks.

These variables only serve to highlight the value of diversification, not merely across different stocks and different market capitalisations, but also across geographies. After all, a decline in sterling against the dollar automatically makes any dollar-denominated holdings more valuable in sterling terms. Viewed in these terms, the greatest danger for investors is not short-term politics, but a failure to diversify. Here at Wellesley we can provide advice on how to diversify your investments effectively, to help you weather any political storm.

Outside the UK

Economic turmoil wasn’t unique to the UK last week, either. Japanese and European stocks both declined; European stocks were hit by Brexit worries and to Italy refusing to amend its budget ahead of the EU’s deadline. This means it is now in contravention of the Stability and Growth Pact, laying it open to punitive measures – however, it is pertinent to remember, interestingly, that Germany and France contravened this very same pact without sanction in 2004.

Moreover, third-quarter growth (annualised) for both Japan and Germany came in negative. In Japan’s case, the dip appeared to reflect unforeseen events – the recent earthquake and severe floods. For Germany, it reflected both pressure on export volumes and more stringent automobile emissions rules – Mercedes-Benz has reported that emissions testing is now taking twice as long as previously.

Meanwhile, the S&P 500 clocked a fourth consecutive day of losses. The oil price continued to decline – from $80 a month ago down to $66 – hitting energy stocks. Technology stocks also slipped on profitability fears, hinging on concerns over Apple’s iPhone business hitting a peak. Despite this, stocks partially recovered later in the week.

Schroders is a fund manager for St. James’s Place.

The information contained is correct as at the date of the article. The information contained does not constitute investment advice and is not intended to state, indicate or imply that current or past results are indicative of future results or expectations. Where the opinions of third parties are offered, these may not necessarily reflect those of St. James’s Place or Wellesley.

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