Five Years On, U.K. Bulls Are Still Shaking Off Brexit Turmoil
(Bloomberg) -- This day in 2016, Britain’s vote to leave the European Union sent tremors across financial markets. Five years and a global health crisis later, U.K. assets are still trying to fully recover from the impact.
In these 1,826 days, the U.K. has seen its third prime minister, the divorce from the EU has happened and a pandemic-ravaged nation has reversed its decade-long policy of fiscal austerity. All that combined has taken its toll on the pound, U.K. stocks and bond markets.
The currency is still 6% lower than it was on the day of the vote. Equities have underperformed their peers in the euro-area and the U.S. Valuations have tumbled 17% since 2016 and benchmark gilt yields remain near lows reached during the post-referendum risk-off rush.
“Brexit has caused regime changes in almost all U.K. asset classes, which are now unwinding,” said Peter Chatwell, head of multi-asset strategy at Mizuho. “Now that it’s been implemented, the market is able to see the new U.K. economy, and slowly but surely the economy is becoming a bit less EU-centric.”
U.K. assets have plenty going for them this year. The Bank of England has used bond purchases to ward off any threat of a credit crisis. The government has unleashed a massive spending plan to lift the economy out of the pandemic effects. A brisk pace of vaccination, reopening hopes and moderated valuations are bringing investors back.
Yet, caution hangs over traders and money managers. Brexit is an exercise in detail and many unresolved issues with the EU continue to simmer. Any of them can flare up any time, plunging markets into disarray.
Here’s a summary of where various U.K. markets stand at the fifth anniversary of the Brexit vote:
Nowhere was the Brexit impact more visible than in the pound, which fell to a three-decade low on the day after the vote. Since then, it has tracked the ups and downs of negotiations, a campaign for a second referendum, multiple elections and the exit concluded in stages by the end of 2020.
Its rally back toward $1.40, driven by a last-minute trade deal with the EU and rapid progress with vaccinations, has convinced some strategists to predict the pound may erase all its post-referendum losses by the end of the year. Others aren’t so sure, and they say lingering issues surrounding the split will continue to weigh on sterling.
The Bank of England’s relative positioning among other major central banks can be a boost, with even the most bearish of analysts revising up their forecasts for the pound for this reason. The central bank announces its latest policy decision on Thursday, and investors are poised to scour the minutes and vote count for any hawkish tilt.
Still, that might not be enough to bring the currency back to its pre-Brexit levels, according to Jane Foley, head of FX strategy at Rabobank.“For the pound to shake off post-Brexit doldrums, it would probably need to see a more hawkish step from the BOE predicated by strength in U.K. economic data,” she said. This week’s BOE decision will be “nothing like enough” to do so, she added.
The pound’s volatility in the past five years has had a profound impact on the country’s stocks, imposing a Brexit discount. It also spurred prolonged underperformance, which only worsened when at the height of the pandemic in 2020.
Companies in the benchmark FTSE 100 Index derive more than 70% of their revenue from abroad, and are whipsawed by currency risk. In dollar terms, the gauge has added a mere 5% since the 2016 vote, while the Euro Stoxx 50 Index is up 36% and the S&P 500 has doubled.
The MSCI U.K. Index has swung from a pre-Brexit premium over the MSCI All-Country Index in forward price-earnings ratios to a 30% discount, the widest in 26 years.
But after being the least preferred among major markets during the Brexit process, London is now seeing the mood change. As investors hunt for value stocks amid rising inflation expectations, cyclical and commodity sectors that can benefit from the global economic recovery are coming to the fore. Cheap valuations and high dividend yields add to the bullish outlook.
Goldman Sachs strategists led by Sharon Bell say U.K. equities offer good value and note this year has seen the strongest foreign inflows since at least 2016. Britain is also Citigroup’s favorite global value trade.
Five years after the Brexit referendum, spreads on sterling corporate bonds are near their lowest level since the global financial crisis and metrics of Brexit premiums in U.K. bonds remain elusive, in no small part thanks to central-bank support.
The BOE announced credit quantitative easing a few weeks after the referendum and spreads did not reach Brexit-day levels again until the coronavirus pandemic, when the bank doubled down on credit purchases to stave off another crisis.
Britain’s divorce from the EU has created opportunity for the world’s developing nations to strike trade and economic deals with the country. That has boosted trading of currencies such as the Chinese yuan and Indian rupee in London, besides bringing borrowers from those nations.
Emerging-market borrowers stepped up sales of bonds denominated in the pound after the 2016 referendum. While absolute numbers remain small, the trend shows companies are increasingly matching their pound revenues with liabilities in the currency.
Gauging both the downside and upside of Brexit on Britain’s financial markets has become challenging, with the onset of the pandemic distorting numbers. Once Britain completes its vaccination drive and emerges from the coronavirus crisis, traders will likely scrutinize the government’s resolution of the pending conflicts with the EU more rigorously.
The pound, and by extension other British assets, may need positive surprises to sustain their gains.
“It needs something impossible to foresee,” said Kit Juckes, the chief currency strategist at Societe Generale SA in London. “I’m sure eventually something good will happen, but it’s not obvious what.”
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