Backing the rookie: fund managers under pressure
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This week, prime minister May started the Brexit clock ticking by triggering Article 50: the official notification that Britain is to leave the European Union. She now has 728 days to negotiate our future.
Knowing the deadline is one thing, but details on the deal itself could be many months away. So should investors be concerned, or keep calm and carry on?
We’ve known this day was coming for some time, so the delivery of the letter was more a grand gesture than a market-defining moment. The pound weakened slightly, there was a modest rise in gilts (although they are already pricing in a long period of at-or-below trend growth) and equity markets did very little.
Over the course of the coming months, sterling is likely to be the most sensitive asset, reacting to any news. However, the impact on our stock and bond markets is less clear.
Richard Buxton, manager of Elite Rated Old Mutual UK Alpha fund, comments: “The investment and business communities are in a frustrating state of limbo as they attempt to respond to the anticipated drip, drip of news flow. Whether or not the protracted negotiations will gradually wear away at corporate and consumer confidence remains an unknown. Of course, the ensuing uncertainty could lead to periods of volatility in markets.”
Holly Cassell, assistant manager of Elite Rated Neptune UK Mid Cap fund, says: “Ongoing developments in the negotiations surrounding the UK’s exit from the EU will likely be scrutinised very closely by both investors and the media, so as details emerge we could well see sharp – and possibly short-lived – moves in both equity markets and sterling, as one or the other party appears to have gained the upper hand. The task for investors is therefore to look through any economic and political noise and focus on identifying long-term trends and opportunities to generate value.”
“The weakening of sterling following the vote to leave the EU makes the valuations of potential UK targets significantly more attractive to overseas acquirers. The uncertainty surrounding Britain’s future outside the EU has deterred many of these would-be buyers from making acquisitions in the UK but with Article 50 now triggered and more detail on the likely outcome of Brexit negotiations emerging, we believe we could see a surge of inbound M&A lift the market.”
As one of Richard Buxton’s European colleagues pointed out recently, for all the bluff and bluster dominating headlines in the UK, the European man on the street doesn’t really care about the UK! On his travels in Europe in the last few weeks, the only person who mentioned Brexit to him was a friend in Vienna. And he’s Welsh. Brexit has a much lower profile (if any) on the television, and in newspapers; it simply isn’t relevant to most Europeans. Indeed, in most parts they have never really considered the UK to be part of Europe.
It’s only at the federal and political level there is real strength of feeling. The fear is that the UK will be the first domino to fall in the unravelling of the European project. So, EU negotiators are incentivised to maintain the integrity of the EU and deter future rebellions. This must be balanced against a desire to maintain trade and political relations with a strategically important economy.
Richard adds that what might have been a nightmare summer ahead for Greece is now likely to result in a further bailout for the floundering member state. ‘Pretend and extend’ looks set to be the order of the day until negotiations with the UK are complete. Indeed, only once the dust has settled on the UK’s departure do we expect an EU reassessment of the European project.
The bigger ‘risk event’ for Europe in the very near future seems to be a Marine Le Pen victory in the French election on 7 May. She has promised to take France out of the euro and a win for her could result in markets falling and the euro taking a big hit. It is worth remembering that election promises are easy to make but sometimes hard to enact – as Donald Trump has found out recently when his attempt to get rid of Obamacare failed.
Given the French and German electoral cycle will take up the first six months of the Brexit process, the crucial period for negotiations will be late 2017 and early 2018. And the deal that is ultimately struck will undoubtedly have far-reaching consequences for the UK economy.
At the moment, some sort of free trade agreement seems to be the most likely outcome. But, as Standard Life Investments pointed out, any new trade deal that requires treaty change, or that qualifies as a ‘mixed agreement’, would necessitate unanimous approval by all 27 remaining members. Countries may opt to have, or formally require (i.e. Ireland), a domestic referendum. Others may need regional legislative approval before being able to provide ratification (i.e. Belgium). So it is always possible that no deal is actually reached and an extension is required.
Early indications are that neither side appears willing to offer room for compromise too soon in the process, so it could easily go down to the wire. The danger then for investors is that the continued uncertainty will be bad news for businesses.
Richard Buxton concludes: “So, we could find ourselves in a situation where it is business as usual, thinking life goes on as normal, untroubled by the period of negotiations. Consumers and businesses will continue to spend. But there will likely come a time when investors, consumers, and corporates will demand more clarity before they commit to X, Y or Z. That’s the time when we will all be forced to reassess the situation.”