Writing this article on the first day of April we had hoped to be at a point where we could analyse and discuss the UK’s future relationship with the EU with some degree of confidence. As events have transpired, we are far from it. By the time you read this, the UK may already have agreed a deal, have crashed out with no deal or even be approaching vote number 12 on Theresa May’s proposal. In the midst of this disarray we therefore take a look at the market moves so far and future investment implications.
Politics over the last few months have been anything but predictable. Whether it be the Speaker’s interventions, historic defeats for the government or the creation of a new centrist party, newspapers have had a field day while the general public no longer knows where to look and is visibly unhappy with the lack of progress. Despite this turbulence, financial markets have remained relatively robust. Sterling has been range bound, the FTSE 100 is up almost 10% year to date1 and UK bond markets have mirrored their international peers. Here we look at the prospects for each of the major asset classes in turn.
Ever since the 2016 referendum, sterling has been the bellwether for overall Brexit sentiment in the markets. So in this volatile environment, how can it be that sterling is the second best performing major developed market currency versus the dollar year to date1 (up almost 3%), and has traded range-bound since August 2018? The currency hit its recent lows last December, after Theresa May postponed the first vote on her deal due to lack of support. Sterling fell to below $1.25 on 11 December - a one day fall of 1.3% - and has been recovering ever since. As parliament has taken more and more control over proceedings, the perceived probability of a no deal has decreased. In fact, rightly or wrongly, very few in the City believe a no deal Brexit is longer an option, even as the clock ticks down. Sterling assets are still unloved and under-owned internationally. The trade weighted exchange rate remains almost 10% below its pre-referendum level, as international investors have avoided UK assets in their portfolios. Hence, if and when any deal is signed with the EU, sterling could see further upside while a no deal exit or a new election should put sterling under pressure again.
UK equity markets have lagged their peers as international flows have suffered. The FTSE 100 has returned almost 30%2 since the referendum on 23 June 2016, which has been boosted by a weaker sterling, while the more domestically focused FTSE 250 has returned 18.5%2. Both have lagged the US S&P 500 which has managed 42%2 (dollar return). UK markets now look cheap on multiple measures, while recent UK economic data has outperformed the Eurozone. It appears that investors may have therefore been waiting for the right moment to increase. FTSE 250 Exchange Traded Funds have seen strong inflows in 2019, while the UK Office for National Statistics recently reported that UK-based investors disinvested from international equities by the largest amount on record in 2018, perhaps suggesting preparation to increase domestic holdings at some point.
Government bonds have also performed well in 2019. UK gilts have returned 3.3% and index linked gilts have returned over 6%1. However, this move has also not been particularly Brexit driven – US treasuries have returned 2.1%1, a reflection of central banks turning more dovish in the face of weaker global economic data. Despite this, the Bank of England has repeatedly stated that they would like to start raising interest rates in the UK once we have more clarity; a move which would put pressure on UK gilt prices.
Disruption, whether due to politics, economics or technology, presents both risks and opportunities. Portfolio positioning around Brexit needs to be more nuanced than just long or short UK equities; other asset classes can have a significant impact on portfolio performance. Moving above the political noise and looking at the bigger picture therefore is essential for positioning a portfolio long-term.