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Should equity markets be concerned about Brexit?

30 August 2019

This week, Boris Johnson moved to prorogue parliament between mid-September and the 14th of October, the day of the Queen's Speech. A decision that has subsequently sparked much controversy and is being challenged in court. Aside from the length of time being a longer period than normal ahead of a Queen's speech, proroguing Parliament is a normal parliamentary procedure. However, these are not normal times. 

I will leave the pros and cons of this to be argued in court by constitutional lawyers, but early legal moves may have little impact as any decisions are likely to be appealed and end up in the Supreme Court. Any reduction in parliamentary time will leave Boris with more flexibility to push ahead with the threat of a no-deal outcome. In the short run, such a deal would be difficult for the UK but would also be bad for the EU, and Ireland in particular. At a time when manufacturing in Germany is in decline due to trade disputes, a no-deal outcome would add to their woes. Therefore, both the EU and the UK have their own incentives to come to an agreement. If the UK Parliament were to remove the threat of no-deal, it would weaken the Prime Minister's hand in negotiating and the EU is unlikely to give ground. The outcome is as ever unclear, with a deal, no-deal, a second referendum and a general election all possible before the end of the year. Street protests against the Prime Minister's actions will only add to the many reasons that make the UK equity market unattractive for international investors.

Short-term moves in equity markets have been driven by trade disputes, and the weakening economic data which may have resulted from the uncertainty around the direction of government policies.

Over the last month, President Trump announced an extension of tariffs on China. Global equity markets sold off but recovered some of the move, as China held off from retaliatory action and talks continue. As the possibility of a hard Brexit has risen, the pound has sold off. Historically this has been beneficial for the FTSE 100 Index, which has a high proportion of companies with overseas earnings, as a weaker pound flatters overseas earnings. However, year-to-date the FTSE 100 Index has underperformed against US and European indices, despite the pound being down 4.5% against the dollar. It appears that a lack of investment interest in the UK market as a result of Brexit uncertainty is taking its toll. The FTSE 100's dividend yield of 5.1% and prospective price-earnings ratio of 12.6 makes the market relatively cheap compared with other developed markets and gilts that currently yield less than 1%, regardless of maturity. Nevertheless, as attractive as the market may appear, relative to other investments, a resolution to the Brexit debate is needed for international investors in the UK to return. 

From an economic perspective, working towards a resolution to the Brexit problem is desirable but if this involves more delays and prevarication, it may not be good news for equity investors. However, those who are prepared to look through the short-term difficulties will find attractive opportunities for longer-term investment.

 

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