What the Latest Brexit Deal Means for Investors
There have been quite a few Brexit deals since the original vote way back in 2016, so you would have been forgiven for rolling your eyes at the prospect of the latest one, the “Windsor Framework.”
Judging by the reaction to yesterday’s deal, a lot of people did. Expectations were low.
So it’s quite heartening to see that the latest attempt to square the Northern Irish circle has surprised most people on the upside. Even the Democratic Unionist Party (the DUP – the main unionist party in Northern Ireland, notoriously reticent about expressing approval of anything) has been as close to cautiously optimistic as it ever gets.
So what is the deal about and why does it matter?
I’m not going to get into the ins and outs (you can see the main “takeaways” here). I’m not a trade specialist or a lawyer and lord knows, the small print of Brexit seems to have ruined many sharper legal minds than mine.
However, from an investment point of view, it’s not the detail that matters. A smoother customs process would be very helpful to all the businesses involved, and certainly a positive development. Yet Northern Ireland accounts for about 2% of UK GDP (Scotland is on about 7% and Wales on 3%), so it’s a good thing to have, rather than a giant leap forward, economically speaking.
(Indeed, as a side note, it’s worth pointing out that despite the political upheaval in Northern Ireland, in economic terms, it has outperformed the rest of the UK in recent years, at least partly, say Samuel Tombs and Gabriella Dickens of Pantheon Macroeconomics, because it has remained aligned with the single market.)
In any case, what is more important is the fact that the UK and the EU are talking to one another like adults, and that the UK itself is less riven by division over this topic (and others, for that matter).
A Major Tone Shift
As Simon French of Panmure Gordon puts it, the real relevance of this deal to investors “is the signal this provides… that the repeated game that is UK-EU dialogue over issues of regulation, economic and social cooperation, and on geopolitical issues is going to be conducted with rather less rancour, and with reduced potential for mutually harmful breakdown.”
In short, both sides would now like to get a mutually acceptable deal done, rather than trying to stick it to the other side. Everyone now has more important things to worry about, and they’d like to be able to focus on those issues instead of wrangling about the details of Brexit.
The passage of time has turned it from an issue that almost everyone feels very strongly about, to one that only a hardcore on either side are unwilling to compromise on.
It’s not just UK-EU relations. The UK government itself is less divided than it was. Both within the major parties and across them, there is more consensus than there has been in some time. Any halfway sensible politician now just wants Brexit to be tidied away.
Labour leader Keir Starmer doesn’t want it to be his future problem to deal with (which is why he says he’ll back it, even if Conservative hold-outs decide against it). Meanwhile any Conservative MP who still hopes to have a job in 2025 realises that being able to point to Brexit in the “done” pile is one achievement that might help them keep power after the next election.
The point is, everyone would rather that this worked. That in itself, is progress.
The UK Discount
That takes us to something we’ve often talked about here — the “UK discount.” Basically, British stocks have been shunned by global investors to an extent that makes no sense based on index composition or geographical location alone.
For example, UK-listed oil companies are cheaper than American oil companies, even although they are all just multinational, global companies whose shares happen to be traded in different places.
Some of this is down to long-term pension fund disinvestment. But at least part of the discount has to be laid at the feet of Brexit.
This has been hugely exacerbated by the fact that on a global basis, US equities have been the only place to be for more than a decade now. As a result, global asset allocators really haven’t needed much excuse to put any other market in the “too hard” bin.
For example, I remember during the euro-zone crisis of the early 2010s (and quite a bit after), plenty of euro-zone equity babies were thrown out with the soupy bathwater of the Greek sovereign debt crisis. Once this shunning had become collective wisdom, it took a long time for fund managers to dip their toes back in, even after it was clear that the risks of a euro-zone collapse were long since past.
So if you accept that at least part of the UK’s cheapness is driven by fears that it is too politically unstable, then this deal has to be seen as progress, regardless of how much the agreement is poked and prodded at as it makes its way through the political sausage machine.
The pound perked up yesterday as the deal was being announced and even managed to hold onto its gains, which suggests the market is optimistic this time too.
Once again, this is a very useful lesson for would-be active investors to learn. The absolute state of things is not what matters – it’s the direction of travel.
When everything is rosy and all that anyone can imagine for the future is sunshine and roses, prices will reflect that. When everything is grim with a forecast for nothing but relentless drizzle and sleet, prices will reflect that too. At that point, you only need a brief break in the clouds for markets to start pricing in some hope.
We’ll see what happens, but my base case scenario is that the UK’s geopolitical discount will properly start to lift this year, and as a result, the UK will lose some of its relative cheapness — particularly as the US market loses some of its growth-era sheen.
That’s a good reason to make sure you have some exposure in your portfolio.
Author: John Stepek, Senior Reporter, Bloomberg
Managing Director, Head of Research