Head - EMEA Investment Strategy
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With little time to go before the UK leaves the EU, the outlook for UK assets remains uncertain.
Brexit is fast approaching crunch-time. On 29 March 2019, the UK will formally cease to be a member of the European Union (EU). With so little time left, the two sides still have a huge amount to agree about their future relationship. If they can’t reach a deal, the fallout for both – but for the UK in particular – would be damaging. Understandably, consumers, businesses, and investors in the UK feel uncertain about the outlook. So, what might happen next?
Despite the stark differences of opinion between the EU and the UK – as well as within the UK’s ruling Conservative Party – we believe a deal will be reached. The UK government is under mounting pressure from UK business to do so. Meanwhile, unity among remaining EU countries around the EU’s hard-line negotiating stance may be weakening. Also, the negative implications of “no deal” – including stockpiling food and medicine in the UK – are helping to focus minds on both sides. We think November could be when an agreement is made.
The deal we expect probably won’t dispel uncertainty entirely, though. Full details of the withdrawal and trade deal may take longer to emerge. One possibility is that the UK’s future EU relationship most resembles Jersey’s current one. Free movement of people would cease. Current trading relations in goods – but not services – would continue, while also allowing the UK could strike new trade agreements with the outside world. The UK’s EU deal will need parliamentary ratification in the UK and across EU member states. This may prove problematic, albeit ultimately successful.
With uncertainty set to persist, UK asset prices are unlikely to see much upside in the coming months. Admittedly, UK equities are inexpensive, reflecting the risks ahead. The average dividend yield on UK large-cap equities is 4.4%. While that may limit potential downside, the lack of clarity on Brexit’s sectoral impacts makes it too early to buy. The British pound could bear the brunt of any short-selling if no Brexit deal is reached. Like equities, Sterling looks cheap, but this again may only restrict how much it can fall. And, while UK government bonds might initially rally amid the turmoil of a no-deal Brexit, they would likely suffer thereafter. We are therefore neutral on UK equities and underweight UK government and investment grade fixed income. But we also believe potential opportunities may arise as negotiations enter their conclusive phase.
Clients can read our full thoughts on these markets in September’s edition of Europe Strategy. And we’ll soon be publishing a special full-length report on Brexit.
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