I received a disconcerting email from my broker yesterday. It advised that, for many months, the brokerage had been watching the Brexit situation and had put in place a ‘number of contingencies’. Regardless of the imminent vote, they promised no disruption to service was anticipated — and should there be a ‘no-deal Brexit’, things were in place to continue to offer the ‘full scope of brokerage services to EU clients.’
With people across the UK stockpiling food and medicine in the case of disruption, the potential and sudden collapse of the many systems that support vital market linkages between the UK and Europe is a major concern. As a world-weary friend of mine visiting from the UK said, ‘The democratic system simply cannot cope with the task of honouring the referendum.’
Fortunately, true to my broker’s word, I logged in this morning to find all market data intact. Despite the biggest defeat of any prime minister in UK democratic history, the GBP had actually strengthened against the NZD.
Shortly after May’s defeat, the pound jumped from $1.867 to $1.889. You can see the jump below.
The FTSE 100 (the share index of the 100 companies with the highest capitalisation on the London Stock Exchange) had priced in what analysts saw as an almost certain defeat. But it was actually up 0.58% at close of trade last night. Tonight (when it opens UK time), things may be a little rockier…
Why is the pound worth more, and why is the FTSE steady so far?
I was up until the early hours of this morning, looking for some buys on my share watch list. I like well-run British companies with solid assets and good dividend yields. In fact, there were no obvious bargains to be had in pre-vote trading. Perhaps, like a smart store owner, the market won’t run a sale at high season.
While most analysts seemed to fail to predict the Brexit vote back in 2016, they’re either a lot smarter now or they smelt Theresa May’s defeat a mile away. Simply put, the defeat was priced in. It was expected. Those predicting the denial of her Brexit deal had already made their bets, short and long, and the market’s position and pricing was based on ‘no’.
Perhaps some easing on the pound can now be expected as traders breathe a sigh of relief. We got through that bout. We’re still conscious. At least we know what we’re in for and can glove up for the next round.
And there’s some promise that this defeat is what is needed to push out a better deal in the next round against the stubborn EU, which has helped the sterling’s rebound. I’ll explain more on this possibility shortly.
Why was May’s deal so resoundingly dumped?
Having spent a recent portion of my life living and working on the periphery of London, I thought her deal was an OK starting point. Somehow she’d managed to maintain access to the single market while pulling out the thorn of free migration with the EU.
Immigration was a big reason for the Leave vote. And to be fair, here in NZ, we share a visa-free border with a country a bit richer than us (Australia). The EU requires the UK to share its border with the likes of Greece (GDP per capita less than half of the UK’s), Romania (GDP per capital less than one-third), and other poorer members.
Control over borders and being able to choose wealthy and skilled migrants is an advantage.
What May failed to price in is that many parliamentarians are ‘Remainers’. They want to stay in the EU and will use the democratic process to derail things.
On the other side, hardcore Brexiters see her deal as a bad one. The UK will still be bound to EU regulations but will pay for the privilege (or prison) of a continued relationship. Too many aspects are still up in the air. And she’d already gone back to the country with a mistimed vote, meaning she now has to rely on the DUP (Democratic Unionist Party of Northern Ireland), who were wholly against her deal from the start.
Where to now? Will the pound and FTSE take another beating?
Jean-Claude Juncker tweeted this morning:
‘I take note with regret of the outcome of the vote in the @HouseofCommons this evening. I urge the #UK to clarify its intentions as soon as possible. Time is almost up #Brexit.’
Indeed, time is almost up — Brexit is scheduled to take place on March 29.
May now faces a vote of no-confidence tomorrow.
There’s a few ways things could go:
Scenario #1: May pulls a rabbit out of the hat and somehow uses the power of this crushing vote to lean on the EU for a better deal and rush it through in time.
Seems a long shot, given how firm the EU has already been and how any such deal has to be approved by the myriad of member states. However, stranger things have happened. Should you believe this a possibility, I would buy GBP and LSE (London Stock Exchange) picks now and wait for the boost.
And perhaps the UK’s bargaining position has not been fully realised. Just under one-in-five German cars such as BMW are sold to Britain. The biggest EU state does not want them crashing off that road.
Scenario #2: May fails the confidence vote and this leads to a successful call for a new country referendum on whether the UK should leave the EU at all.
David Cameron had to draw on the Liberal Democrats’ support when he came to power, and their presence in powerful electorates around London cannot be underestimated. The Lib Dems have been pushing for a new referendum.
People I speak to in the UK are just tired of Brexit. As one grandmother put it, ‘If we’d known what we were truly in for, we’d never have voted for Brexit to begin with.’
In this scenario, I’d buy GBP and LSE stocks now. If somehow Britain ends up remaining in the EU, the markets will love the end to uncertainty, and they will jump!
Scenario #3: More time is sought, Brexit drags on, and a deal with compromises chomping at the edges is slowly pushed through.
The 29 March deadline would have to be extended. It would not surprise me if this is the most likely outcome. My observation of living in an old country in Europe is that things take far longer than they do in the New World. It took three months for us to open a bank account, and a year to start the repairs on my apartment building. This seems perfectly normal. Europeans are used to delay. As a New Zealander, I thought I’d gone back 30 years.
In terms of the markets under this scenario, there would be slower improvement and things may get worse before they get better. But there will be an eventual turn as the UK and EU finally find ground and continue to hobble along together but apart.
Scenario #4: The UK crashes out of the EU with no deal and falls on WTO rules.
This is my personal favourite and a real chance for the UK to find independence and potential success. Let’s face it: the Eurozone has been a dead space of anaemic growth and declining opportunity when compared to advancing regions such as the Asia-Pacific.
Done well, the UK can cut regulation, taxes, become the Singapore of Europe and forge new free-trade relationships with faster-growing nations. Trump has already expressed his concerns that May’s Brexit deal could derail a US-UK free-trade agreement. So, with this out of the way, the UK could well become a favoured trading partner with the world’s largest economy.
This path is the riskiest, and there would be a long period where the UK finds itself cut adrift and in total need of reinvention. It took independent Singapore more than 20 years to rise through such challenges.
In this case, market opportunity in the UK would be a risky and very long-term bet. I’d still be buying, though, if there’s a major sale at the store.
Well, it could even go other ways, but for me to suggest any further would be simply like throwing a dart at the dartboard after one too many pints at the pub.
Meanwhile, the team and I at Money Morning watch this space with interest. A hard Brexit will impact on global market uncertainty in the same way as the US-China trade tensions have done so. New Zealand is a small blip in the global marketplace, while some two-thirds of the world’s wealth sits in Europe and North America.
Keep calm and carry on.
Analyst, Money Morning New Zealand