Market Views: Bracing for no-deal Brexit under BoJo
Back in January, AsianInvestor asked a group of investment management pundits for their views on Britain's looming departure from the European Union and its possible effects on markets.
The date, outlook and premise for Brexit have since changed dramatically as the initial plans for a negotiated exit deal have floundered in the UK parliament and, most recently, as ardent Brexiteer Boris Johnson has taken over from Theresa May as UK prime minister.
Although seemingly equipped with an ability to influence public opinion and divert attention with his eccentric behaviour and statements, Johnson is having less success wooing an EU he has consistently criticised since the 1990s.
Thus the clock appears to be ticking down towards a hard, 'no deal' Brexit by the revised date of October 31. That is notwithstanding the possibility of Johnson being ousted by a no-confidence vote reportedly being planned by a group of pro-remain MPs.
How would a no-deal outcome affect markets? Are investors prepared for all the possible scenarios, knowing the risk has been there since the referendum vote held on June 23, 2016, more than three years ago?
We asked four investment experts – covering equities, fixed income and real estate –for their views on the likely outcome and implications.
The following extracts have been edited for brevity and clarity.
Quentin Fitzsimmons, fixed income portfolio manager (based in London)
T. Rowe Price
A no-deal Brexit is now the most likely outcome. Along with the jitters in the market caused by Boris Johnson’s comments over the leadership campaign, there is a growing belief that the global fundamentals are deteriorating. These developments have driven investors to safe-haven assets, causing UK sovereign bonds to rally sharply in recent weeks.
I expect the current period of uncertainty to continue as the Brexit deadline approaches. This could extend the rally in UK gilts. However, if the UK leaves without deal on October 31 and there is clear, immediate disruption to the supply of goods, the resulting panic could push yields sharply lower.
Will Prime Minister Boris Johnson stick to his hard-line stance or will he soften his approach? It is not easy to predict which way he will go. He communicates very well but it is difficult to know what he really means. In any case, I do not believe he will be able to secure a better deal from the EU.
The best way fixed income investors can prepare for Brexit is to remain focused on fundamentals across the global opportunity set. Global central banks have turned dovish and expectations for multiple rate cuts, not only in the US but also for the eurozone, are now priced in.
How global growth evolves over the next few months will be critical. Signs of a stabilisation could bolster risk assets but put core government bonds under pressure. By contrast, further signs of a slowdown could leave risk markets vulnerable to a correction. Keeping some powder dry to exploit market dislocations and take advantage of any valuation set-backs seems prudent at this time.
Luke Bartholomew, investment strategist (London)
Aberdeen Standard Investments
It is clear from the data that the risk of a 'no deal' Brexit has been weighing on business investment in the UK. Despite very strong fundamentals – low unemployment, growing wage pressure, cheap finance, and strong corporate balance sheets – the UK has sharply lagged international peers in investment spending. This is obviously related to the risks around Brexit.
It is important to stress that this is related to the risk of a specific bad outcome, not uncertainty per se. So clarifying the situation and delivering a no-deal Brexit will not lead to a pick-up in investment. This is because the certainty of a bad outcome is worse than ongoing uncertainty about various different possible outcomes.
Indeed, in the event of no-deal we would expect the UK to enter into a recession over the next year, even though monetary and fiscal policy will become much more supportive. In a no-deal scenario, sterling would end up much lower, which would push up inflation over the next few years. This will squeeze real incomes, without doing much to boost exporters given the newly constrained trading arrangements the UK will be facing.
The financial industry is among the most prepared sectors for a no-deal Brexit, and the Bank of England has conducted rigorous stress tests to ensure the viability of the financial sector in that outcome. However, it is plausible that the City will gradually become a less desirable place to do business.
Hugh Gimber, global market strategist (London)
JP Morgan Asset Management
The British pound is the clearest market barometer of no-deal fears, and the currency’s recent slide highlights that investors are becoming increasingly jittery. We acknowledge that the risk of a no-deal exit is rising, yet we continue to believe that such an outcome is not the most likely scenario unless a general election or a second referendum were to provide a mandate for it.
That said, no-deal rhetoric from the UK government is set to intensify over the coming weeks. If markets do price in a higher likelihood of a disorderly Brexit, we see room for sterling to fall further from current levels. We would not advise clients take large positions on sterling given two-sided risks.
[Still, if it happens, a] decline in the pound should be supportive of the UK stock market given the high proportion of foreign revenues generated by UK-listed companies. We would expect large-cap stocks to outperform small caps in this scenario, given the lower exposure of large caps to the domestic economy.
In fixed income markets, UK government bonds have already rallied strongly this year across the curve driven by a combination of domestic and global factors. If a no-deal scenario becomes more likely, we would expect rising expectations of policy easing from the Bank of England to put further downward pressure on UK gilt yields.
With the probability of a general election rising, investors considering UK assets must also look to factor in the potential market impact of the Labour party taking power, which potentially would focus on less market-friendly policies.
Tim Graham, senior director for international capital (Hong Kong)
JLL Asia Pacific
The UK remains a highly attractive destination for property investment. It is the second-largest real estate market globally and London has been the world’s most traded city [in terms of property assets] for seven of the past 10 years. London also sees consistently the largest cross-border real estate flows of any market globally.
JLL’s Global Real Estate Transparency Index shows the UK is the world’s most transparent market, with high levels of liquidity, strong legal and regulatory frameworks and robust governance of listed vehicles.
International property investors also benefit from attractive currency conditions, with sterling trading at a discount of 15% to 20% against most major global currencies since the EU referendum.
Prime office yields remain attractive and are significantly higher than comparable European and global cities. There remains a significant amount of capital to invest globally in real estate, and the UK remains a key destination for global capital, but the majority are waiting for increased political clarity.
UK property investment strategies are well balanced across the risk curve and, tellingly, our Investor Confidence Survey suggests that 73% of all respondents plan to be a net investor in UK real estate over the next 12 months.