And the Oscar for best actress goes to...

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25/02/2019
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Theresa May, for her magnificent performance in looking like she actually wants to deliver Brexit. Cue her acceptance speech with very memorable soundbites; Brexit means Brexit is always a favourite. However, Brexit does not win Best Picture because unfortunately Theresa May does not have a very supportive cast. The rest of the ensemble do not seem to be reading from the same script as Theresa May. The Remainers and the Brexiteers within her own party have both tried to steal the show and sabotage the current deal that Theresa May is trying to push through Parliament, although, thus far, they have been unsuccessful in their bids.

Last week we saw several members of the Labour party leave and form their own political party, the Independent Group. We were then treated to three resignations from the Conservative party on Wednesday, just one hour before Prime Minister’s Questions. They too also joined the Independent Group. This was obviously done for dramatic effect, although actually there was very little to be surprised about, with the resignations being led by Anna Soubry, who has long campaigned for the UK to remain within the European Union. It will certainly be interesting to see if there are any more defectors in either party willing to make the leap. However, if this new group is to gain any momentum, it needs a big name to defect, otherwise it is guaranteed to be a box office flop. While neither will want to hear this, unfortunately both Chuka Umunna, and Anna Soubry, are merely headliners in a low budget (straight to DVD) B movie.
 
In order to challenge the status quo and the dominance of both Labour and the Conservatives, they will need an A-list star; someone from the current cabinet, shadow cabinet, or someone who has significant influence among the backbenchers and who can guarantee box office success. Once they have this,  then the Independent Group can challenge the status quo. Until that happens the two-party system will continue. However, the Independent Group can take solace in the fact that they now have the same number of seats as the Liberal Democrats, and yet the party is merely a week old!
 
So, what happens now?  
 
Theresa May is still insisting that her plan gets the backing from Parliament, however, as the title suggests, this may not be really what she wants. We have a little over a month before we are due to leave the EU and there remains very little to show that Theresa May’s Brexit plan is going to get the support it needs. She has delayed the meaningful vote again to the 12th March – some say ruthlessly running down the clock. This could potentially leave two outcomes; either we continue to remain in the EU (for the short term at least) by extending the withdrawal agreement, or we fall out of the EU without agreement, succumbing to a hard Brexit. We think the former is the more likely option, especially as it is looking increasingly like the EU cannot afford to lose the UK without agreement.
 
Should the UK fall out without a deal, then not only will the EU fail to secure its multi-billion divorce deal, but there are clear signs that there are storm clouds on the horizon. Both France and Germany are struggling economically. Germany did manage to avoid a technical recession in 2018, but only by reporting 0% growth in the fourth quarter (Source: Federal Statistics Office), thus avoiding two consecutive periods of negative growth.
 
Market analysts are always keen to point out the weakness of our domestic market, and indeed if you are going to look at global markets on a local GBP currency basis, then the FTSE 100 has been the worst performing stock market. Since the vote to leave the EU on the 23rd June 2016 it has returned 25.75%, whereas the Dow Jones (the best performer) has returned 71.36% (Source: FE Analytics). However, looking at performance just in Sterling doesn’t tell the whole story. If you look at performance on a local currency basis then actually the UK has not performed as badly as the French and German markets since our vote to leave the EU:
 

Source: FE analytics 2019

In fact, we have performed marginally better than France and significantly better than Germany. Of course, correlations between the stock market and economic performance are limited, but often the stock market is the first to react. This could be a sign of things to come.
 
While Donald Trump’s ire is currently directed at China, you can bet that once the issue in hand has been resolved his attention will surely swing in Germany’s direction. Donald Trump cannot afford not to have an enemy; his political nous has been built on the US being a victim of the rest of the world. With the 2020 presidential election looming, it would be a sure bet that he will turn his crosshairs on Germany (and the EU). According to the United States Census Bureau, in 2018 the US trade deficit with Germany stood at over $62 billion. The deficit with the EU as a whole is $92 billion, and as the largest trading partner of the United States, Donald Trump certainly holds all the cards when it comes to trade renegotiations, should they happen.  
 
The powerhouse of the German economy - the automotive sector - should be very concerned if Donald Trump does introduce tariffs on its cars. While many people point out that Donald Trump is being unfair, it can be hard for the EU to retaliate within reason. Currently the US imposes a 2.5% tariff on car imports from the EU, however, the EU imposes a 10% tariff on all imports to the EU. This hardly sounds fair if you are a US car manufacturer trying to sell within the EU. It is in the interests of the EU to impose tariffs on a manufacturers outside the EU to protect the European market and German car manufacturers from foreign competition. To coin a familiar phrase, it sounds like it is the EU having their cake and eating it!
 
If Donald Trump does introduce significantly high tariffs on EU cars, then it could well be the straw that breaks the camel’s back when it comes to the German economy. So, a delay may help Britain’s negotiating position if there is no appetite for Theresa May’s current Brexit deal.  After all, the current deal was negotiated when the UK was in a position of weakness relative to the dominant economic powerhouses of Europe. While many economists argue that leaving the EU will be bad for the economy, it will be equally bad for the EU if we leave without a deal when the two largest contributors are facing economic difficulties. Brexiteers remain reluctant to delay our withdrawal from the EU, however, their tune might change if Brexit is delayed and the UK is able to better the deal currently on offer. With Theresa May confirming that she won’t stand in another election, this may well be the curtain call she desires as well.
 
While a hard Brexit hasn’t been ruled out (nor should it), it still leaves investors with an uncertain outcome. While a delay will initially be welcomed by UK markets, and indeed others, any prolonged delay will mean a further period of uncertainty, every investor’s worse enemy.

Volatile Sterling divides UK equity returns

The FTSE 100 lost -0.8% last week, in a week when most its international peers made modest gains.  The UK large cap index, which derives most of its revenue overseas, faced the headwind of a rising Sterling.  The more domestically orientated FTSE 250 index rose +1.5% over the same period.

The Pound appreciated +1.2% versus the safe-haven US Dollar which has come under pressure as investor risk appetite very gradually returns. Sterling also rose +0.9% against the Euro. Despite Brexit negotiations running down to the wire, speculation has mounted that the chance of a soft-Brexit deal getting through parliament may be growing slightly.  Reports circulated late in the week that the EU is open to adding a legally binding appendix to the agreement allowing the UK to exit the Irish backstop with enough notice.

In the US, the S&P 500 closed with a gain of +0.6%.  Another round of negotiations between Trump officials and China unfolded with apparent progress on several of the more contentious issues, bringing hope that an agreement may be close.  The US rate rise cycle has halted recently in the face of rising trade tensions and waning economic growth.  The minutes of the January Federal Reserve meeting, released last week, revealed that most of the committee thought it best to prepare a plan to stop reducing the central bank’s balance sheet in the coming months.

Elsewhere, Manufacturing weakness continues to weigh on Europe and Japan as updated Flash Purchasing Managers' Indices (PMI) for February showed contracting levels of activity in these regions.  European equity markets though were unfazed; Germany’s DAX 30 climbed +1.4% whilst the French CAC 40 closed +1.2% higher.  Japan’s Nikkei 225 index meanwhile recorded a +2.5% gain.

The price of oil made further gains last week. Brent crude, the primarily European benchmark, added a modest +1.3% over the course of the week but this extends a rally that has seen the commodity rise in excess of +30% from its low over the Christmas period.  This trend chimes with other commodity markets which have seen a sharp rally in recent weeks, most notably Iron ore.

Data sources: FE analytics and Forex Factory

The Week Ahead

Parliament hosts its first inflation report hearings of 2019 tomorrow with the Governor of the Bank of England and his team set to present on the economic outlook for the country. The Central Bank also releases a series of consumer borrowing figures later in the week, covering areas such as credit card usage and mortgage approvals. Key domestic data to keep on include Nationwide’s house price index and January’s manufacturing PMI.

It’s a particular busy week for US related numbers, the standout being revised GDP on Thursday. The number has been delayed by around 4 weeks due to the Government shutdown and growth is expected to be revised down by 120 basis points to +2.6% (quarterly). Other data includes building permits and housing starts in addition to the Institute for Supply Managements PMI equivalent on Friday.

In the Eurozone, inflation comes back into focus with the latest CPI figures, both headline and core released later in the week. Unemployment meanwhile is expected to have held steady at the decade low of 7.9%. Inflation is also the stand out release in Japan with the BoJ releasing its preferred measure of core-CPI in the early hours of tomorrow morning. The Chinese landscape is dominated by production indices with the latest Government and Caixin calculated PMI’s due before the close of play on Friday.

Data source: Datastream