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Navigating Brexit and beyond

Navigating Brexit and beyond

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After more than three and a half years of parliamentary and political arguments since the referendum vote for Brexit, the UK has withdrawn from the European Union (EU).

Yet while the UK will have formally left the EU, nothing will change immediately. During the transition period, which runs to December 2020, the UK will remain bound to the bloc’s rules, while terms for a trade relationship are negotiated. Fundamentally this means, as we have acknowledged before, that the precise nature of the UK’s future relationship with the EU, and its full implications, remains uncertain.

So, what do we know about how the reality of Brexit might affect investors?

What happens next?

Time is short, and negotiations will begin swiftly. Both the UK and the EU have said they will prioritise hammering out a free trade deal agreement, working intensively to redefine their future relationship and avoid economic fallout.

Despite scepticism from the EU over the timeframe, Prime Minister Boris Johnson is striking an optimistic tone that a trade deal will be agreed by December 2020, and a cliff edge, no-deal exit will be avoided. Without a trade deal, Britain will fall back on so-called basic World Trade Organisation terms, potentially resulting in paperwork, tariffs and delays at ports. However, chief Brexit negotiator, Michel Barnier, has added that a variety of stop-gap measures may be adopted in some areas, if a comprehensive deal cannot be successfully negotiated by then.

Trying to balance the desire for deals with both the EU and the United States will take some manoeuvring. Chancellor Sajid Javid’s stated intent to give precedence to negotiating an EU deal over a US one prompted headlines at Davos last week.

For many investors, eyes will be fixed on the end of the transition period in December 2020, wondering how to ensure that their portfolios are protected against the UK leaving without a free trade deal in place, even if it is only a stop-gap in some areas.

However, the next five months of negotiations need to be considered as well. These talks have the potential to impact investor confidence and stock market performance, as markets will be highly sensitive to any updates on progress, or lack of it.

Progress on the negotiations will be assessed at the EU summit in June. This is also the deadline for Britain to request an extension to the transition period, although Johnson has so far ruled this out, and based on his approach to the negotiations in 2019, we see little reason to believe he will change his mind.

Overall, the UK economy is resilient, despite any Brexit-related uncertainties, with the International Monetary Fund (IMF) leaving its forecast for growth this year and next unchanged, at 1.4% and 1.5% respectively, assuming an orderly exit from the EU and gradual transition period. Most other forecasters are a little more cautious, but continue to expect growth. The Bank of England notably considered a precautionary cut to interest rates as inflation and demand have been underwhelming during the final months of 2019, but ultimately decided against it as evidence built of a recovery in house prices which have traditionally coincided with stronger retail sales.

Looking further ahead

The longer-term shape of the UK economy post-Brexit remains difficult to predict with any certainty. Much will depend on how individual industries are affected by divergence from EU rules.

The automotive and aerospace industries – two of the UK manufacturing industry’s main exporters – fear a dramatic downturn in business if UK rules conflict with the EU’s. They are particularly reliant on their ability to produce, export and import without tariffs, and the smooth running of just-in-time supply chains. If borderless trade ends following Brexit, this could potentially damage the competitiveness of the British car industry and deter international manufacturers.

Nonetheless, the British government’s view seems to be that if we are not ‘in’, we should not seek to align for the sake of it. Freedom to diverge from EU rules could improve the prospects for many industries, as governor of the Bank of England Mark Carney underlined when he advocated that the City should be regulated here rather than by the EU.

The Agriculture Bill, for example, proposes major changes to farming as the UK prepares to leave the EU. It promises that, rather than relying on billions of pounds worth of subsidies from the EU, funding for British farmers will be linked to environmental projects, with a seven-year transition period for farmers to adjust to the changes. While it remains thin on detail it gives a sense of the opportunities that exist for the UK to rethink existing approaches after it leaves the EU.

What does this mean for investors?

The hope is that the coming months will provide some clarity over what the future holds, as negotiators make the case for a competitive, post-Brexit economy. However, there will, of course, be winners and losers, and challenges lie ahead. We should get more of a sense of the government’s vision following the chancellor’s first post-Brexit budget in March.

In reality, though, we can expect a return to the kind of brinksmanship which has been a feature of Brexit-related negotiations with the EU – particularly since Boris Johnson’s team has taken charge. Historically, such episodes have weighed on the value of the pound and caused the outperformance of stocks which derive their revenues from overseas. This has provided us with opportunities when we have felt the government’s rhetoric will not be matched by its actions. It seems unlikely that the markets will learn from their previous mistakes and ignore such posturing. Having moved on from the topic of Brexit, investors now assume that Boris Johnson, protected by a strong majority, will eventually seek a meaningful free trade deal with the EU. Even if that ends up being the destination, we’re more confident that the journey will be a difficult one as the Prime Minister strikes a more combative tone during the negotiations, depressing the pound.

Beyond Brexit, the global economy will be influenced by many other factors over the coming months, such as the US presidential election, amongst others. Whatever occurs, we will be carefully monitoring portfolios, and maintaining their diversity in order to afford some protection against any market events which do occur. We will also maximise any opportunities that arise this year, and in a future post-Brexit world.

 

 

Guy Foster, Head of Research
Guy leads Brewin Dolphin’s Research team, providing recommendations on tactical investment strategy to Brewin Dolphin’s investment managers and strategic recommendations to the group’s Asset Allocation Committee. He is a CFA charterholder, holds the CISI Diploma, and is a member of the Society of Business Economists. Guy frequently discusses financial issues with the written and televised media as well as presenting to the staff and clients of Brewin Dolphin.


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The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Ltd.

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