Brexit: What now?
Portfolio Manager Thomas Banks offers perspective on the continuing Brexit saga and potential market impacts.
Q: Now that a Brexit deal has been voted down a third time, what are you watching—especially in terms of best and worst outcomes? April 12 is the deadline for the U.K. to inform the European Union (EU) of its intentions, with a conditional extension until May 22 should the British Parliament reach a Withdrawal Agreement. The worst outcome would be approaching April 12 without clear direction from the U.K. and the EU holding fast to the April 12 deadline; this would increase the likelihood of a no-deal Brexit.
Our base-case scenario remains an extension to Article 50—the EU clause outlining steps a country must take to voluntarily leave the bloc. This, we believe, ultimately would culminate in a slightly softer version gaining acceptance.
The threat of a “no deal” Brexit cannot be ruled out but remains a lower probability versus the likelihood of an extension as all parties view it as the least preferred option.
Q: What have been impacts to the U.K. and the European economies and markets so far? Since Brexit’s approval on June 23, 2016, the local currency returns of the U.K. and European markets have been broadly in-line with each other but have trailed other major developed markets such as the U.S. and Japan by double-digit margins. Within the U.K., the Brexit impact has been more pronounced in the more domestically oriented small- and mid-company stocks, with the FTSE 250 underperforming the FTSE 100 by close to 10% on a total return basis since the initial Brexit vote.
Decelerating growth has been the biggest factor in the U.K.’s and eurozone’s underperformance relative to other developed markets since the Brexit vote. Prior to that, U.K. GDP was growing consistently above a 2% rate, but last year slowed to 1.4%. There’s no question some of the deceleration was due to external factors, but the approximate 6% decline in business investment in the U.K. since 2016 highlights the effects Brexit uncertainty is having on business confidence and spending plans. GDP growth in the eurozone has been more resilient, slowing from 2% in 2016 to 1.8% in 2018, although growth slowed sequentially throughout last year to 1.1% in the fourth quarter as the effects of the U.S.-China trade war impacted export demand.
Q: Any possible impacts to U.S. stocks? The impact on most U.S. companies should be minimal. The majority of multinationals generate a fraction of their sales from the U.K., and in a worst-case no-deal exit, weaker economic conditions could be offset by expected foreign exchange translation gains as the British pound is expected to depreciate further.
Q: Are workarounds being developed if there’s a no-deal Brexit? The U.K. government announced its plan to smooth the transition in the event of a no-deal Brexit, which would put its trading relationships under World Trade Organization rules. In this scenario, the government plans to cut tariffs to zero on 87% of imports by value, up from 80% currently. The plan would favor products from non-EU countries with 92% of non-EU imports becoming tariff free, up from 56% currently. 82% of imports from the EU would be tariff free, down from 100% currently.
The impact on the banking sector will be closely watched, although there are contingency plans to mitigate potential fallout. According to Bloomberg, U.K. banks have been working with regulators to get EU licenses, and five of the largest banks intend to move 750 billion euros in assets to Frankfurt along with hundreds of jobs.
Even with plans in place, there is no question a no-deal Brexit would hurt the U.K. and EU economies. The hit to U.K.’s economy if it leaves the EU without a trade deal would be around 6% of its GDP, according to International Monetary Fund projections. It expects financial services, chemicals and automotive industries to be most affected, while farms, food processors and oil might be more resilient.