Should we be worried by Brexit deadlock?

James Horniman, Portfolio Manager

Brexit campaigners promised us a financial nirvana if we left the EU. The Remain camp painted a Dante-esque picture of Britain sinking into economic squalor. We find ourselves somewhere in between these two extremes – Brexit purgatory.

But this is certainly not hell and it is worth reminding ourselves of that fact, lest we become too despondent at the ongoing Brexit deadlock.

In the immediate aftermath of the Brexit vote the pound plunged, suffering its biggest intra-day drop of modern times – down 11.9%. It continued to roll downhill for a while longer, falling from around $1.48 pre-Brexit to as low as $1.21. Today it is at $1.30. We did not panic then and should not panic now. Since that date the index of top 250 UK companies has risen 27% (and at one point was as much as 42% higher), albeit in the context of rising global markets.

Confirmation of a no-deal would almost certainly see further pressure on the pound, but that does not have to be a calamitous shock, as it is already lower than it would have been if we had voted yes.

It is worth also thinking about how resilient businesses and markets can be to political storms. Last quarter we faced concerns over trade wars, currency crises and financial stresses in emerging market countries and upward pressure on inflation. What happened? North American equity markets produced the strongest return for the quarter, with the S&P 500 index up 8% in local terms, fuelled by rising corporate earnings, tax cuts and share buybacks. Japan quietly posted a 6% return in yen, following positive economic data, the re-election of Premier Shinzo Abe and the recognition that it had perhaps been unfairly caught up in trade disputes. Emerging markets have had a torrid year – down 23% from their 2018 peak, but delivered a flat return in the quarter, despite August currency crises in Argentina, Brazil and Turkey. And Brexit may have dampened interest in the UK but markets were only down 1%.

Markets have a tendency to overreact to nasty surprises but a no-deal should not be a surprise – and recent UK equity market performance suggests a no-deal is already priced in to some extent. If a no-deal is the outcome of these long talks, the boat may rock but it would be a surprise if it capsized. That said, we are not in this business to make clients seasick. The market sell-offs last week suggest that these tensions need to be set against the context of general late bull market anxiety. August marked the longest rally in equity markets in recent history and that means investors are on edge and prone to bouts of panic.

We are underweight UK stocks and hold record amounts of cash after taking profits from assets that have either performed particularly well or that may not fare as well in the next stage of the market cycle. Our heightened cash levels are intended to help protect clients from the worst of market turmoil. They also enable us to seize any opportunities that might arise in the coming weeks.

Most of the UK stocks we hold generate a significant proportion of their income from overseas, which means they look set to benefit from a falling pound – as will our exposure to global shares. We keep revisiting fundamentals as we seek to ensure we are not holding stocks on valuations that cannot be justified.

Brexit, the fractured leadership of the UK government, as well as the risk of instability in the run up to the US mid-term elections, all remain at the front of our minds, but we see no reason for immediate action in the light of the current Brexit deadlock.

James Horniman

19 Oct 2018

This is not advice and you should not act on the content of this comment without taking professional advice. Opinions and views expressed are personal and subject to change. No representation or warranty, express or implied, is made of given by or on behalf of the Firm or its partners or any other person as to the accuracy, completeness or fairness of the information or opinions contained in this document, and no responsibility or liability is accepted for any such information or opinions.

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