Market Thinking

making sense of the narrative

The B word (s)

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In my previous job, I had a Swedish Italian CEO, with a Dutch second in command and a management board that was almost entirely French. Suffice to say that writing anything about Brexit was not encouraged. In fact, that hasn’t troubled me too much in the last three years since the extra-ordinary twists and turns of the UK’s attempts to break from the EU have made the UK market essentially uninvestable for anyone without UK liabilities. Now, however, it is getting close enough to an October 31st deadline to start thinking about how to position portfolios, especially as Parliament is set to return shortly.

The news for the noise traders (in FX) this morning is that PM Boris Johnson (the second B word) is likely to suspend Parliament shortly after its return ahead of a fresh Queen’s speech scheduled for October 14. This has produced predictable outrage from the Remain side, but is clearly aimed at frustrating their attempts to frustrate Brexit itself. To date, the narrative has been shaped by the Remainers that Leaving is ‘bad’ and Remaining is ‘good’ such that the FX market appears to be tracking the prospects of a deal or no deal. To suggest otherwise risks extreme reactions – as evidenced by the below the line comments in the hugely pro Remain newspapers such as the FT and the Times. But markets are markets and the narrative can change. Investors need to think about what is likely to happen, not what they think should happen. With that in mind, here are a few of the points that are currently being overlooked (to be generous) but which may well constitute a new narrative to drive sterling and UK markets higher if, as seems to be the case right now, there is no-one left to buy into the negative narrative.

First, article 50 was triggered in March 2017, which gave a two year timetable to leave, during which there were provisions to do a deal to minimise disruption to the economy. That has not happened, largely for political reasons, but there is no requirement for there to be a deal. Parliament has the right to scrutinise any deal, but not to stop the UK leaving. Theresa May’s Withdrawal Agreement was a deal proposed to Parliament but was rejected three times. It is important to recognise that the notion of ‘crashing out without a deal’ has been elevated to the level of economic disaster for political reasons, not economic ones. Leaving without ‘a deal’ means disruption, not disaster. It does not mean arrangements are not already in place (they are), nor in terms of trade does it mean that a deal can not be negotiated the following day – indeed technically that is exactly when the UK can do trade deals – with the EU or anyone else.

For investors, the winners and losers will depend on exactly how the UK proceeds. For example, if it chooses no tariffs (which would be sensible), then being outside the customs union means increased competition, especially in food and clothing and by extension lower prices for consumers and competitive risks for producers. For homework it would be worth looking at the large corporations (European as well as UK and even US) that are most opposed to Brexit, for they probably have some insight into competitive threats. Second, if post October 31st, the latest iterations of so called project fear turn out to be as absent as the original ones, then the FX market is likely to turn on its head and start rewarding positive trade initiatives – as happened in Australia when the government negotiated multiple trade deals on a two year timetable.

In the meantime, even without the currency, it is worth considering some of the ‘value’ currently embedded in UK equities, which are currently yielding 10x UK government bonds. Surely even Dominic Grieves projections can’t be that bad?