At the two-year anniversary of the vote for Brexit, the final outline of the UK’s relationship with the EU and its wider trading partners is still undetermined. While uncertainty is normally bad news for markets – and has certainly suppressed the pound’s value since the vote – UK assets have remained remarkably resilient since the vote. Here, investors discuss the impact of Brexit uncertainty on UK investments as the UK’s formal withdrawal nears.
Azad Zangana, senior European economist, Schroders
This Saturday, two years will have passed since the UK’s historic referendum on leaving the EU, yet the big questions over the future relationship with the UK’s biggest trading partner remain unanswered.
Will the UK remain in the EU’s customs union? Will it be a member of the single market? Will the UK face tariffs on its exports? The only near certainty the government can provide is that in 281 days the UK will cease to be a full member of the EU on 29 March 2019.
Some progress was made at the end of 2017, with an agreement on the rights of individuals, and on the Brexit divorce bill. However, progress on trade and other areas of co-operation have stalled due to the Irish conundrum: how to re-introduce borders and keep the Irish peace deal alive? This remains a major obstacle to progressing talks, but a more fundamental problem has been the lack of clarity from the UK government on what it wants. Clearly, “Brexit means Brexit”, and “no deal is better than a bad deal”, but these are nothing more than sound bites.
The government is divided on how best to proceed with regards to major issues such as the customs union and trade. Hard-line Brexit supporters are pushing for a quick exit with little ties, while more moderate members and those that campaigned against Brexit support ongoing collaboration. The latter object to a “hard-Brexit”, but are willing to give Prime Minister (PM) Theresa May a chance to deliver on her promises of a Brexit that satisfies everyone, regardless of whether this is realistic.
Meanwhile, the government’s bruising encounters in recent weeks with the rest of parliament, specifically the House of Lords – the UK’s upper house – have shown that it cannot ignore the views of members in charting its course. The risk of a “hard-Brexit” is significant, and opposition members are keen to stop the government opting to walk away from negotiations.
Earlier this year, the EU and UK agreed a transition period, which will last from April 2019 to December 2020. The terms of the transition period have not been confirmed, but we assume that full membership in all but name will continue, including the UK’s contribution to the EU’s budget and free movement of labour to the ire of Brexit supporters. This period will help businesses adjust to the new proposed relationship, and for governments to prepare their infrastructure. However, a destination for this transition is required, and this remains missing.
It appears that the PM is pushing for ongoing membership of a customs union in order to satisfy the Irish peace deal, but only until a permanent solution can be found. However, the risk of this temporary arrangement becoming permanent has prompted the Secretary of State for Exiting the EU, David Davis, to push for a deadline being included of December 2021.
Phil Harris, manager of the EdenTree UK Equity Growth Fund
Since the vote for Brexit, UK stocks have proved more resilient than many had expected. The thesis was that mid-caps, often seen as barometer for UK plc, would be badly buffeted. But the data shows that the demise of mid-caps has been greatly exaggerated. Indeed, since the Brexit vote the FTSE 250 has actually outstripped the FTSE 100 returning 27.14% and 16.17% respectively. This is despite a considerable tailwind of currency weakness lifting the earnings of FTSE 100 overseas earners.
“While, of course, many UK mid-caps with significant overseas sales have benefited from the fall of sterling against the major currencies, Britain’s domestically focused mid-caps stocks have also performed. For example, as spending on low ticket items has been maintained at the expense of larger ticket purchases, companies such as Hotel Chocolate and Fever Tree have thrived. Both companies tap into the desire for affordable discretionary items even as political uncertainty impacts consumer sentiment.
“In this environment, it is important to be selective but secular growth trends – which are unlikely to dissipate while the UK economy remains relatively stable – can provide a rich harvest for some of the UK highest quality mid- and small-sized companies. Moreover, gathering political clouds are likely to provide fresh points of entry as valuations continue to look frothy.
Rogier Quirijns, portfolio manager of the Cohen & Steers European Real Estate Securities Strategy
The impact of the vote for Brexit is already being felt in several sectors, with rising costs and continued uncertainty partially blamed for a succession of business collapses and investment cutbacks.
For example, UK retailers remain under pressure, as demonstrated by a wave of store closures and bankruptcies (CVA’s) so far this year. Store closures are already impacting rents for traditional retail properties, a trend we do not anticipate reversing at any point soon. We believe a structural shift is coming, as both values and rents face downward pressure.
The London office market has been fuelled by significant new supply entering the market over the last few years. However, we expect demand for these properties to slide as the Brexit process unfolds over the next 12–24 months. We have already seen several companies announce staff moves away from London since the 2016 vote.
Despite these challenges, property investors should not avoid the UK altogether, in our opinion. While traditional retail is experiencing structural and Brexit-related headwinds, we believe e-commerce is the beneficiary of strong structural tailwinds. Property investors can benefit from this transition. Urban logistic facilities for example are grossly under supplied, particularly in London.
Similarly, alternative sectors such as healthcare, student housing and self-storage are all backed by secular trends that are unlikely to be damaged by the Brexit deal.
Louise Dudley, portfolio manager, Hermes Investment Management
Still a lot of uncertainty remains – lack of visibility on outcomes makes it difficult for companies to plan proactively and they are therefore forced to assume worst case scenarios. This could result in lower growth and therefore UK businesses are less attractive from an investment perspective. We remain underweight UK for these reasons – where we do have exposure it is mostly to companies earning their revenues outside the UK.
UK businesses are starting to anticipate and factor in increased costs related to Brexit. For non-UK companies with offices here they will be looking to ensure they can continue to operate as efficiently as possible which may include being lured overseas.
Adrien Pichoud, chief economist at SYZ Asset Management
May was marked by an impressive divergence across European equity markets as the Eurostoxx closed with a loss of 3.6%, while the FTSE 100 registered a solid gain of 2.2% in May and 8.8% over the past two months. A brighter economic outlook is not the reason for this recent rally as uncertainties continue to surround the fate of the British economy after Brexit. Investors should look elsewhere to find the most likely cause of this surge.
The FTSE 100 is very much skewed toward companies that make their revenues abroad, hence companies that are very sensitive to exchange rates. With a lower pound, profits of those companies are worth more in sterling terms.
Finally, there has been an increase in corporate activity globally, with a number of companies looking to make acquisitions. In this context, a weaker pound made UK assets cheaper for international investors, pushing the stock market higher.
