Brexit: the second wave

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05/08/2020
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The newswires are becoming ever more focused on the potential for a second wave of COVID-19. This is unsurprising as various cities across the world go back into lockdown or at least have their populace freedoms curtailed due to an increase in infections. This was always a risk, but many hoped either the summer weather, mutations of the virus itself or the implementation of the lockdown would prevent this. Clearly, this virus is very effective at transmission and continues to find human hosts in order to thrive. A vaccine is probably the only way out for our lives to return to normal.

Part of that normality is worrying about the passage of Brexit. Whilst the absence of the endless political discussion has been welcome, most would probably choose Brexit tedium over COVID-19. However, not unlike the virus, it continues to fester and there are serious economic implications this winter if we don’t get on top of it.

The UK equity market and sterling have both been impacted by the government’s perceived poor handling of the virus when looking at the relative performance of other countries’ virus strategies. In sterling terms, the differential between the FTSE All Share Index (the UK equity market) and the FTSE World Ex-UK Index (the rest of the world excluding the UK) since the beginning of 2020 is 20% (source: FE Analytics).  Some of this will be due to concerns regarding the COVID-19 impact on UK earnings but also, as sterling weakens, the returns from overseas businesses when converted back into sterling will be boosted.

However there has also been no relief from the overhang of a potential no-deal Brexit. It is difficult for Boris Johnson to agree to an extension having been elected on a promise to ‘Get Brexit Done’. It would be a gift to the opposition parties if the Prime Minister agreed to an extension and a significant manifesto U-turn. The government is on the back foot following its COVID-19 strategy as it is, the last thing it needs is a self-inflicted Brexiteer backlash.

Unfortunately for the UK markets and sterling, this keeps the no-deal cliff edge scenario very much alive. Whilst in the EU, the UK was often on the naughty step for being awkward and not part of the Euro inner club. For now, the UK remains in this transition phase, which is perpetuating the painful position of half out, half in with no more clarity as to what lies ahead than the day after the original vote on 23 June 2016. That was over four years ago.

To put that in wider context, the same indices above, in sterling terms, have delivered returns of 13.7% and 72.0% since the Brexit vote showing just how far the UK equity market has fallen behind the rest of the world (source: FE Analytics).

COVID-19 has not helped the situation with regard to negotiating a post-Brexit deal nor discussing post-EU deals with other nations. Most governments have bigger fish to fry than the UK’s Brexit squabbles. If the UK ends up with a no deal arrangement, then it will fall back onto World Trade Organisation (WTO) rules with recent references having been made by Boris Johnson to an EU-Australia type arrangement.

So, what is this? In a nutshell, few countries in the world operate under basic WTO rules – they are too simplistic and limited for most to want to follow them. Many have separate agreements on top covering anything from cars to washing machines, clothing to fresh produce, depending on what the import/export demand is on both sides for each part of the bilateral agreement. However, there is actually no agreed deal with Australia, but negotiations have been underway since June 2018 to establish a Free Trade Agreement. Boris Johnson has most likely referenced this for two reasons.

Firstly, if much of the heavy lifting has already been done with Australia, replicating this for the UK should be much quicker and will provide a template. Secondly, the EU will be accused of post-Brexit UK discrimination if the UK cannot be treated in the same way as Australia where tariff free trade is being considered. This also follows from the recent deal that Japan agreed with the EU. If the UK is now treated as a ‘third country’, to quote the EU’s own definition, then why shouldn’t the UK also potentially have the same trade arrangements as other third countries such as Japan and Australia?

The UK is now more than halfway through the transition period and there has also been very little news on the trade front regarding agreements with other non-EU countries, which was supposedly one of the big benefits of leaving the EU.

There will no doubt be increased commentary on this as we enter the autumn and the markets need to brace for a second wave of Brexit as well as whatever the virus still has to throw at us, which, from the perspective of an overseas investor, means steer clear of sterling based assets.

 

 

Source: FTSE International Limited ("FTSE") © FTSE 2020. "FTSE ®" is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under licence. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE's express written consent.

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