The outlook for the UK and related investments is likely to remain cloudy following the triggering of Article 50, expected 29 March, which will officially start the process of the UK leaving the EU.
Will Hobbs, head of Investment Strategy at Barclays Wealth & Investments suggests that there are risks currently to UK growth amid the uncertainty that has been unleashed around the issue.
“The UK economy is not the primary factor influencing capital markets, even in the UK,” he said.
“For investors in the world’s stock and bond markets, the fates of the European and US economies dominate the outlook.”
“However, sterling does have an important role to play in investment portfolios and it is hard to see an imminent bounce back in the currency with all the negotiation headlines and a likely tougher economic backdrop to endure in coming quarters. Sterling looks cheap relative to historical valuations, but it can get cheaper still. The most recent employment and inflation reports did highlight the real pay squeeze starting to bite the UK’s all important consumer, which all things being equal should see growth slide to a lower trend for the moment.”
“For investors to focus solely on the political dramas will likely lead them to miss the more important story, which is that the world economy looks revived. There will be bumps in the road ahead; in the short run, positioning in stocks and bonds both look quite stretched in their mirrored trajectories, but the fundamental support for the moves seen since the second half of last year is more robust than many argue, suggesting that there may be more of the same ahead.”
Meanwhile, MSCI has published its outlook for institutional portfolios on the basis of three potential outcomes: a rough and a smooth Brexit, and a Brexit that benefits the UK.
Thomas Verbraken, vice president, Risk and Regulation Research, said the stress testing performed by MSCI suggested that a typical globally diversified portfolio of 60% equity/40% fixed income stood to lose up to 8% of its value, or gain 3.5%, depending on the outcome.
Should the negotiations set to begin after the triggering of Article 50 fail, then MSCI sees a risk of the UK suffering a net outflow of “talent, capital and foreign direct investment, while investment and spending slow.”
In the stress testing for this scenario, MSCI said the pound could lose another 16% against the dollar and euro, while equity markets in the UK and EU would fall 37% and 21% respectively.”
“The risk of default for sovereign debt in the UK and across Europe boosts 10-year yields by 20 basis points in the UK and 60 basis points in countries at the EU’s periphery. Corporate credit spreads widen, which exacerbates systemic risk.”
In such a scenario, MSCI has calculated that investors would be better off with a globally diversified multi-asset portfolio. But even this could lose “as much as 7.8%”
In MSCI’s second test, it assumes that a deal is struck in negotiations with the EU27, including a trade deal.
However, even under this assumption, the short-term risk is for stagflation, because it will take time for UK deals with other trading partners to come to fruition. The pound would fall by some 12% and 10-year UK government bond yields would rise by 120 basis points.
In this situation, a globally diversified multi-asset portfolio would lose 1.6% of its value, while equity portfolios would shed more, they would shed far less than under a ‘rough Brexit’ scenario, MSCI’s figures show.
Brexit benefitting UK
The third situation outlined by MSCI involves anti-EU parties taking power across Europe, which then come to view the UK as “an island of safety, thanks in part to its bilateral trade relations with the US, China and others.”
In this scenario, MSCI predicts the pound would gain 16% against the dollar, with both growth and inflation rising. UK equities would gain 4.2%, while equities across Continental Europe would fall 11%. Italy’s 10-year government debt yield spread against the German bund would rise by 60 basis points.
For investors, the best model portfolio to be in under such a situation would be a globally diversified fixed income one, which would lose 2.2% on average, MSCI said.