We do, finally, seem to be edging towards some kind of initial resolution as regards Brexit. As I’ve long maintained, the answer always was some kind of negotiated settlement that would look, smell and feel a great deal like the first withdrawal agreement. Which it does bar the backstop and leaving Northern Ireland in a strange customs limbo. My own feeling is that this inevitable.
What has been more surprising is the behavior of so many MPs. Brexit was always going to be about the art of the possible, which involves a massive dose of compromise from all sides. The Brexiteers probably haven’t got their No Deal Clean Brexit (whatever that is) while Remainers were never realistically going to get their close customs arrangement akin to Norway’s deal with the EU (more’s the pity in my view). Once one accepts these limitations – and as a Remainer, I always assumed that People’s Vote was a complete nonstarter – then the current deal probably looks like the best alternative to No Deal. But the behavior of many Remainer MPs has, I would humbly suggest, antagonised a large part of moderate opinion, much of it Remainer. The overall objective of many MPs seems to be kill Brexit dead by whatever means. Equally the behavior of many Spartans has been nothing short of calamitous.
I’m sure that once Brexit has turned into something less controversial (!?!?) we’ll launch a proper review to examine how we got into this mess. The role of MPs and the speaker must form a part of this truth and reconciliation process!
Anyway, back to investment basics. One of the great untruths of the Brexit campaign was the idea that the impact on the UK economy would be minimal. I never believed the Project Fear catastrophe scenario, but it was always obvious to me that the uncertainty created by Brexit would have a huge, short term impact – if only in terms of delayed decisions. The most recent estimate of this impact over the last few months comes from a Barclays Research report from last week:
“Manufacturing in the doldrums: The August activity print showed that production remained soft with manufacturing contracting more than expected, businesses not stockpiling and service activity growth unusually volatile, probably due to stop-and-go Brexit headlines. With previous months revised up, the carry-over for Q3 is now a solid 0.4pp. All things considered, we revised up our Q3 GDP forecast by 0.1pp to 0.4% q/q but nudged down Q4 GDP by 0.1pp to 0.1% q/q. Overall, that leaves annual growth at 1.3% for this year but pushes down 2020 growth by 0.1pp to -0.1% due to calendar effects.”
If wed do finally reach the first stage of Brexit, we should see a reversal of a large part of this uncertainty – although quite what the long term strategic cost will be is anyone’s guess. That should set the scene for a large reversal in short to medium term sentiment towards the UK and its stockmarket. Come November 1st I’ll be looking to increase my exposure to UK domestic-focused equities, preferably through the Aurora Investment Trust which has a large collection of UK focused businesses (and where I am a non-exec).
One downside of this reversal in sentiment will be a bounceback in sterling. My working assumptions had always been that if we had No Deal we’d hit parity with the Euro and $1.10. Once we have some form of agreement, I think 1.15 euros to the £ and $1.30 to $1.35 would be more sensible. If the latter scenario does materialize, diversified UK investors could be in for something of a surprise.
A stronger pound will have an inevitable impact on those investors with a strong foreign currency exposure within their portfolios. That could be terrible news in the short term for investors in global equity investment trusts. That narrative certainly emerges in a research note out last week from funds analysts at Stifel. The table below lists the investment trusts with the highest FX exposure. Here’s the Stifel note:….
Sterling has recovered by around +7% both against the US dollar and the euro since mid-August and we expect currency volatility to continue to be an important factor in investors’ returns over the next few weeks. We are therefore reviewing the sensitivity of the funds investing internationally to changes in sterling. The recent low point in the £=US$ rate was 1.20 on 9th August and it had subsequently recovered by 8% to 1.29 yesterday. The August low was a 9% decline from the previous high of 1.32 on 3rd May. There has also been a strengthening of around 7% in the £=€ rate since mid-August. This has had a material negative impact on the NAVs of funds with high exposure to non-sterling assets. By way of example, Scottish Mortgage, which has almost all of its assets in non-sterling currency, will have seen a currency headwind of around 7% on its NAV since mid-August, and this is a key factor in the NAV falling by -4-7% since then
One last investment titbit thankfully unrelated to Brexit.
Recent Bank of America Merril Lynch data shows that the number of unprofitable companies going public has surged to “tech bubble levels” – the percentage of companies going public that have yet to generate positive earnings has reached 70%.
Something of a warning me thinks.