In a speech at Lancaster House on 17 January, Prime Minister Theresa May officially confirmed that the UK plans to leave the European Union single market.
Since the Brexit referendum result was revealed in June investors have grappled with an uncertain economic outlook for the UK – does May’s speech change anything? Headlines following May’s speech noted that the pound rallied 1.74 per cent, but the most economically negative points had already been leaked in the days leading up to her speech sending the currency in a downward slide.
Alongside exit from the single market, May will also take the UK out of the customs union, while retaining certain aspects beneficial to the UK. The Government would seek frictionless, tariff-free trade, while rejecting other elements of the customs union that could prevent the UK from striking its own free-trade deals with other countries, May clarified.
In a positive for markets, parliament would get a chance to vote on the deal and the UK would seek a phased implementation period. By the end of the speech May warned the EU the UK was prepared to become a tax haven if it did not get the deal it wanted.
Within the funds space May’s speech has received mixed reviews. It struck “exactly the right tone”, according to Waverton Investment Management managing director Algernon Percy. “Confident and firm, but at the same time conciliatory,” he says, noting the UK had passed the point of maximum uncertainty. Kames Capital chief investment officer Stephen Jones says May clearly articulated to the EU why it would not be in their best interests to let the existing partnership disappear in a puff of smoke.
On the other hand, investment director at The Adviser Centre Peter Toogood describes the UK’s threats as “childish”. “The attitude, the behaviour, the approach is despicable and more importantly it does not reflect how the European Union operates. They do not respond to threats,” Toogood says. He rubbishes claims that German carmakers will lobby their government for a good trade deal, pointing to the Russian sanctions as an example where European principles have come before
Devere Group international investment strategist Tom Elliott says May’s indication that security cooperation will form part of its negotiation strategy is “unforgiveable”. “If we deliberately allowed lives to be taken as part of our EU negotiation strategy it wouldn’t play well in this country let alone abroad.”
The tax haven is an empty threat, reckons Elliot. “It’s simply not going to happen, it’s a silly thing for her to say. There’s no way the public is going to sacrifice the NHS on behalf of Brexit.” Elliot says there are two camps of Brexiteers: globalists and protectionists. “That tension is there and it could erupt between now and when negotiations end and seriously weaken Theresa May’s bargaining hand.”
Markets may be underestimating European leaders unwillingness to compromise, particularly with the rise of populism, says Pioneer Investments head of European fixed income Cosimo Marasciulo. “Both sides are taking a hardline.”
The asset manager is currently underweight UK gilts, but Marasciulo says there could be opportunities to go long in the second half of the year based on an environment of lower growth and an accommodative central bank. Regarding the threat to turn the UK into tax haven, Marasciulo says that would make them bearish as less revenues impact fiscal deficit and debt to GDP ratio.
“A lot of the data you need to make high conviction views you simply won’t know until a lot later in the process,” says Insight Investment product specialist Andy Burgess. “Financials from the UK perspective have the most risk on the downside.”
“Equities still look like the best place to put your money over the next three years,” says technical investment director at Rowan Dartington Guy Stephens, as sterling remains weak and supports the FTSE 100. However, he warns that equities will be volatile and the 2016 rally will be an anomaly.
“The UK market went up 16 per cent last year. I think we’ll look back at that in retrospect and think ‘wow, that was such a good year’.”
EdenTree Amity UK fund manager Ketan Patel says the large cap index can be broken up into three buckets: US dollar earners, exporters and diversified consumer stocks. “All three face a very difficult environment given the current political uncertainty.” The first is dominated by banks and commodities, while those in the last are highly valued, offering low growth and are most exposed to swings in currency. Patel points to Mears, Porvair, Victrex, Trifast and Horizon Discovery as examples of small and mid caps in the portfolio that have outperformed all the major UK indices, including the FTSE 100.
“The outlook is unclear for companies and that is bad,” says Chelsea Financial Services managing director Darius McDermott. While car sales have held up and people are still going out to pubs and restaurants, McDermott argues companies are probably not spending.
McDermott reckons sterling is cheap on a long-term basis and if it strengthens may deliver opportunities on the domestic side. “That’s the type of opportunity that throws up good opportunities for active managers,” McDermott says.
Active opportunities won’t just be in the UK, says Stephens. “Trump, Brexit, European elections, these will all provide the equity markets with volatility which provides opportunities. But you need to have some cash on the side so that when it does happen you can jump in.”
Sterling will not weaken much further, but it will not suddenly recover either, Stephens says. “It will all get very stodgy and a bit boring really. In which case you just revert back to income – quality income stocks. You just have to be very careful as you wind your way through it. If May does agree a transitional deal that will cause sterling to rally that means the FTSE 100 will reverse.”
Ultimately, problems at home should be an opportunity for UK investors to abandon their home bias, Elliot says. There is more goodness to come in small and mid caps if Trump’s fiscal package gets through Congress, Elliot says. But he warns that it will likely end in an “almighty crash” two years down the line. “The economy will weaken as we head towards this hard Brexit. Go abroad, diversify and benefit from a falling pound by being in assets denominated in other currencies.”