After nearly two-and-a-half turbulent years, the Brexit process is heading for a showdown at a parliamentary vote. The outcome of this will determine whether Brexit will be a hard one or not. Although the discussion about the possibility of whether a second referendum on Brexit will happen has been brought up by various stakeholders in recent months, the idea has so far failed to gather the necessary momentum for it to be on the cards. This is primarily due to the fact that the two major political parties are not in favour, or at least at this moment in time.
In light of the constantly changing market environment and expectations surrounding a potential Brexit deal, markets seem to have become pretty immune to this. This was particularly evident with the flat market reaction, following an extraordinary summit in Brussels, where European Union leaders signed off Theresa May’s withdrawal agreement. An interpretation to this could be that market sentiment has stabilised itself, and whatever the outcome of the parliamentary vote, the FTSE index is not likely to significantly outperform or underperform other global indices. As a matter of fact, Japanese investment bank Nomura believes that the market is currently already pricing in the risk of a hard Brexit.
This factor, together with confirmation that all seven British banks and building societies in this year’s Bank of England (BOE) stress test passed, indicating they could withstand a disorderly Brexit without having to curb lending, goes to reassure Brexiteers’ thinking that the impending doom scenario is improbable and unrealistic.
Indicators all seem to point towards the reluctance of UK politicians to believe that a no deal will have a catastrophic effect on the British economy, as Theresa May does not seem to have the numbers to get the negotiated Brexit deal ratified by the House of Commons.
Investors who firmly believe that, whatever the outcome of the vote, the UK economy will be more or less unaffected or will perhaps even thrive, are currently adopting a neutral stance with the intention of entering the market with the next dip. Some analysts also believe that, should Brexit uncertainty be removed soon, the sterling could revisit this year’s high of $1.43.
Other models recently developed, such as that by Nomura bank, predict that, with a no deal, the sterling could drop over eight per cent in value and touch the $1.18 price level from the current $1.28. Jane Foley, the head of foreign exchange strategy at Rabobank, also believes that the closer we get to the vote, the greater the likelihood that pessimism will prevail and that investors will short the sterling in greater volumes. Most fund managers have so far been reluctant to go down this route due to the high level of uncertainty prevailing. They do believe that they could end up at the wrong side of the bet, should the decision be contrary to what they are expecting.
The UK economy will be more or less unaffected or will perhaps even thrive
Alberto Gallo, head of macro strategies at Algebris Investments – a London based asset management company, has in fact confirmed that they do not have a position on the sterling at the time being. “It is very hard for people to hold a position in such a binary environment” he said. This ‘no action’ strategy contrasts with what is being projected by the government and the BOE alike.
A government report issued this week projected a drop of 10.7 per cent in Gross Domestic Product (GDP), in the event of a hard Brexit, over 15 years. The BOE went a step further by predicting a similar decline but in just over five years. This slump, which could turn out to be the steepest one since World War II, would send property prices crashing down by around 30 per cent and the sterling by approximately 25 per cent. This fall will be partly triggered by the shrinking supply of European Union workers.
The negative effects on the British economy are not only likely to be triggered by a hard Brexit, but also under Theresa May’s Brexit plan. As a matter of fact, earlier on this week, the oldest British independent economic research institute, the National Institute for Economic and Social Research (NIESR) published a report which states that, after 10 years out of the European Union, UK’s economy would be almost four per cent smaller than it would be if the country never exits. The NIESR assessment also goes into government borrowing and predicts that under Theresa May’s plan, this would be 2.6 per cent higher than it is today, while government revenue will be 1.5 per cent to two per cent in the long-run.
Following yesterday’s first day of the G20 summit, Theresa May has tried to convince world leaders and sceptical UK MP’s alike that the proposed Brexit deal – pending parliamentary approval on December 11 – is the way forward to mitigate the negative consequences of an otherwise hard Brexit scenario. She also intends to promote global trade, albeit US President Donald Trump expressed his scepticism on Britain achieving a trade deal with his country. In his opinion, Britain would still be significantly aligned with Brussels’ rules.
Investors have warned that anyone hoping that financial markets will ride to the rescue of Theresa May’s Brexit deal, is likely to be disappointed. All stakeholders seem to be of the view that Brexit will bring about negative effects, at least in the short term, but differences on the longer-term performance of the economy exist. Perhaps the uncertainty revolving around any Brexit scenario might instigate further the possibility of a second referendum taking place, which could potentially reverse the financial market performance witnessed so far, including the impact on the sterling.
Panicked and rushed decisions are never a solution to investment market turbulence. The ideal way forward is for an investor to schedule a meeting with his financial advisor so that a risk profile is defined. Following this, the principal options available are the following: retain the sterling investments and ride the waves; retain the sterling but invest in collective investment schemes that have an underlying exposure to global assets; switch investments to euro hedged securities which hold UK underlying assets; or sell the sterling or part thereof, depending on the overall portfolio allocation.
The next few days and weeks will surely keep investors searching for news on what could happen next.
This article was prepared by David Baldacchino, MSc Wealth Management (Edinburgh), B.Com (Hons) Banking and Finance (Melit.), DipFA, is investment advisor at Jesmond Mizzi Financial Advisors Limited. This article does not intend to give investment advice and the contents therein should not be construed as such. The Company is licensed to conduct investment services by the MFSA and is a Member of the Malta Stock Exchange and a member of the Atlas Group. The directors or related parties, including the company, and their clients are likely to have an interest in securities mentioned in this article. Investors should remember that past performance is no guide to future performance and that the value of investments may go down as well as up. For further information contact Jesmond Mizzi Financial Advisors Limited of 67, Level 3, South Street, Valletta, on 2122 4410, or e-mail david.baldacchino@jesmondmizzi.com.
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