Brexit update by Tatton Investments 2nd November 2018
Below is an update of Tatton’s view of the issues around Brexit. It is their view but we subscribe to the contents. Please read at your leisure and contact me if you wish to discuss. Regards, Steve.
Brexit, the biggest decision made by the British in recent history steps ever closer to reality, March 2019 when Britain is no longer a member of the EU. Dominic Raab, Secretary of State for Exiting the European Union, implied this week that he was confident of a deal by November 21, only to backtrack to what has become the now standard ‘no progress’ negotiating position of the UK Government and the EU. This ‘nearly there, but no change’ and little detail on what has actually been negotiated led to 700,000 people marching in London and a seeming endless bickering between the politicians on all sides.
Against this – for many – unnerving backdrop of apparent lack of real progress on negotiations, we thought it time to provide investors with an update on our thoughts regarding Brexit and the impact on your investments.
It seems likely, even with a deal, that there will be, or agreed that there can be, an extension of transition periods and a temporary continuation of the customs union to prevent trade disruptions. This very EU like fudge, with a more benign rather than negative public position from both sides, has pushed a definitive decision far enough away to not cause an immediate crisis.
The UK and the EU are apparently locked in this nerve-wracking (certainly for the public) standoff. This, coupled with the seeming unwillingness of the opposing political sides within the UK’s political leadership and parliament to break ground and commit to a policy makes me suspect that we are witnessing deliberate rather than situational brinkmanship on the side of the government. The more to the wire negotiations appear and the later Theresa May’s team presents any form of Brexit deal, the less the time, opportunity and public support for those who prefer chaos to pragmatic compromise – to agitate against it. Jeremy Corbyn controls his shadow cabinet very tightly, easier to watch the Tories self-destruct than expose his own party’s divisions on Brexit.
It seems that the weeks until year end can be expected to remain as unnerving as the weeks since the summer, which may well put renewed but temporary pressure on £-Sterling, until at the last minute the looming crisis is resolved in a nail-biting finale which both sides will hope to make the result ‘sellable’ to their respective electorates.
All this high-profile politics doesn’t alleviate any of our concerns as investment managers or your concerns as investors on how the UK’s future relationship with the EU will impact on our lives. This is, of course, understandable despite truly domestic British assets forming a relatively small section of our overall investment portfolios compared to global assets. So, with the nation still staring down the barrel of a no deal gun, it may come as a surprise then that, at Tatton, we’re relatively sanguine about the whole thing – for the time being at least.
Yes, there are thick clouds of uncertainty over the UK’s future and serious unknowns to consider. How long will this government last? Will we soon have another election or even referendum? What options would such a referendum even pose? And that’s just the short term; the shape of Britain’s long-term arrangement with the EU is even more uncertain.
There are certain things we can be fairly confident about. The most important of these is that, while March 2019’s official exit will undoubtedly be a significant milestone, it’s unlikely to see too many changes to the actual business environment. A transitional period and a BRINO (Brexit in name only) for the near future, without a solid long-term agreement, are the most likely outcomes for next year.
The fact that the October deadline for an agreement was missed all but confirms this in our eyes. Put simply, there is no way to have a substantial breakaway from European laws in five months’ time without significant damage to both British and (to a somewhat lesser extent) European economies. While many businesses have contingencies for the various strengths of Brexit, such a sudden shift would force them into a difficult position. This is something that politicians and electorates on both sides couldn’t abide. Unlike the longer-term arrangements, this could be easily avoided without too much complication or loss of face.
As strange is it may sound, we think this is especially true considering the weakness of politicians on all sides. Rarely do you get aggressive or far-reaching decisions with weak leadership. At home, Theresa May’s minority government faces both internal and external opposition. While some of this is pushing her towards a harder Brexit, a larger proportion is pushing her the other way. In Germany, the Merkel era looks shaky and now even has an end date. General Eurosceptic sentiment across the continent is pushing national governments and even Brusselite technocrats away from causing a pan-European economic upset for the sake of proving the supremacy and integrity of the remaining EU27.
All this points to a continuation of the Brexit muddle-through in the short term. During that time, the UK should be able to take full advantage of EU member status with the added bonus of a low-valued currency. A lower £-Sterling price gives exporters and advantage that has boosted the British economy and gone some way to redressing its underlying structural issues. So long as this continues and demand from Europe doesn’t fall off too dramatically, we see a relatively good picture for the UK in 2019.
We must, however, tinge this rosy picture with a fair dose of caution. Economically, Britain is in a fragile balance. Recent inflation data suggests that even modest growth is likely to generate inflation pressures. Combined with continued weakness in the housing market, this has given the Bank of England a serious headache on whether to raise rates more aggressively in case £-Sterling came under undue pressure – and risk choking off the economic activity – or hold back – and risk inflation getting out of hand.
Politically, things are equally fragile. British politics has three main Brexit camps who all have a fair chance of being in power in a few months’ time: The Labour Party, who are pushing for a Brexit lite; the Johnson/Rees-Mogg axis of the Tory party, under whom a hard Brexit looks fairly certain; and Theresa May’s unassuming band of Tory MPs, who are not overly keen on Brexit but will have to seek re-nomination from a Tory membership which appears firmly pro-Brexit. Given that market expectations for the UK are almost directly correlated to the expected strength of Brexit, the one comforting part of this balance is that two out of three of those options avoid a damaging hard Brexit.
On the continent, things are much the same. European electorates would prefer the UK to remain but, as the exit is inevitable, businesses (in particular) just want the outcome that leads to least disruption. The Eurocrats in Brussels are ideologically opposed to Brexit and have shown in the past, with Greece and Italy, that they’re willing to forgo easy solutions for the sake of purity. On the whole, the national governments are somewhere in the middle
The difference here however is that, while Europhobic Tory backbenchers are noisy, they aren’t in control. The Eurocrats – who combine their technocratic management style with a dogmatism usually reserved for more extreme ideologues – are. As ever in European politics, this makes easy solutions more difficult.
But even the self-styled protectors of the European project are ultimately subordinate to national leaders. If the economic threat to electorates is big enough, national leaders will put enough pressure on Brussels to make a deal. As yet they have not applied real pressure on the Eurocrats to make a deal happen.
When they do, this could well lead to an arrangement somewhere between a Switzerland/Norway model deal or (in a worst-case scenario) a Canada-plus. None of these trade models with the EU are likely to be as good or better than full membership, but then this may be the price to pay for increased levels of sovereignty and being able to negotiate free trade deals with other global regions on our own.
To use Theresa May’s words, “not a walk in the park”, but “not the end of the world either” is what we would expect as a worst case for March 2019.
What does this mean for our allocations and your investments? In our assessment, the shunned £-Sterling and UK stocks are currently lower valued than the medium-term outlook justifies, which is why we removed the previous UK underweight from portfolios in August. You should remember that we allocate globally and so our view on the UK is in terms of how we can best position your investments, not what we want out of Brexit. On that basis, Brexit becomes less of our immediate focus, because the levers of Trump, China are having more significant effects globally, and that is where most of your portfolio holdings are doing their business and thus where we seek to generate returns.
Please talk to Steve to see our monthly or quarterly portfolio factsheets which contain detailed breakdowns of our allocations. We frequently write about Brexit in the Tatton Weekly which you can subscribe, through your adviser, if you would like to know more about our ongoing research and investment thinking.