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No Halloween scare for UK stocks

Anthony Fensom  |  28 Oct 2019Text size  Decrease  Increase  |  
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Britain’s ongoing Brexit saga has seemingly failed to spook investors, despite Boris Johnson’s failed pledge to quit the European Union by Halloween.

And with the British economy projected to ride out the uncertainty, analysts suggest a stronger outlook lies ahead, providing a deal can be done.

As of close of trade on 25 October, Britain’s benchmark FTSE 100 index was at 7,324, down from its year high of 7,727 but still showing a healthy one-year return of 10.4 per cent. The British pound has also hit five-year highs recently on hopes that the world’s sixth-largest economy can avoid a feared “no-deal” Brexit, which could erase more than 9 per cent of GDP growth over the next 15 years.

By contrast, the Prime Minister’s Brexit deal is expected to cost Britain 6.7 per cent in GDP growth, or about 130 billion pounds ($244 billion) compared to staying in the EU, according to UK government estimates.

In the event of a no-deal Brexit, the exchange rate would probably fall, CPI inflation rise and GDP growth slow,” the Bank of England’s monetary policy committee said at its latest meeting in September, where it kept its key rate at 0.75 per cent.

In contrast, greater clarity around a path towards a “smooth Brexit” could see demand rise and the economy strengthen, the central bank said, suggesting it may need to start increasing its key rate should such a scenario eventuate.

Other forecasters also see the British economy continuing to expand, albeit at a sluggish pace.

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In its October “World Economic Outlook” report, the International Monetary Fund predicted that the UK economy would expand by 1.2 per cent this year and 1.4 per cent in 2020, in line with the Eurozone’s projected growth rates.

London-based consultancy Capital Economics warns against further Brexit delays, however.

“The most likely scenario seems to be that Brexit is delayed until 31 January and that an election takes place before then,” Capital Economics’ chief UK economist, Paul Dales said in a 25 October report.

“A delay to 31 January is not a huge blow for the economy, but by prolonging the uncertainty it’s an extra drag.”

Under its “repeated delays” scenario, the London-based consultancy sees GDP growth easing from 1.3 per cent this year to about 1 per cent in 2020, with the pound staying around US$1.28.

On the positive side, three-quarters of British companies surveyed have already undertaken some form of contingency planning for Brexit. The Johnson government has also pledged a range of initiatives to offset the impact, ranging from fiscal stimulus measures such as income tax cuts and greater schools funding to “freeports” tariff-free zones at several port cities.

Finding bargains in Brexit bin

The pound’s decline since the Brexit vote has swollen the foreign currency earnings of Britain’s biggest companies, with some 70 per cent of FTSE 100 earnings derived overseas.

However, expectations of a more orderly Brexit have recently boosted the more domestically focused FTSE 250, which has more companies operating solely in Britain.

For Australian investors, the FTSE 100 offers the benefit of both geographic and sector diversification, since it is “overweight” in consumer staples and energy but “underweight” in financials, materials and property, according to BetaShares.

UK stocks have also offered investors relatively attractive dividend yields compared to global and Australian benchmarks.

As at June 2019, the FTSE 100 was trading on a net dividend yield of 4.8 per cent, ahead of the S&P ASX 200 index (4.5 per cent) and the MSCI World index’s 2.5 per cent.

In the short term though, UK stocks could come under more selling pressure as the Brexit negotiations continue.

Borish Johnson steps out of Lets Take Back Control car

British Prime Minister Boris Johnson. Three-quarters of British companies surveyed have already undertaken some form of contingency planning for Brexit

Nikko Asset Management’s chief global strategist, John Vail sees the FTSE 100 slipping to 6970 by the end of March 2020, although “if things turn out a lot worse in the world or for Brexit, our targets could be quite a bit lower.”

Yet longer term, BetaShares chief economist David Bassanese sees the UK economy “setting itself up well in terms of new trade agreements and a more deregulatory system … the trickiest time will be over the next few months as uncertainty intensifies.”

Capital Economics expects a Brexit deal to drive an acceleration in British GDP growth in 2020 and 2021, allowing domestic factors to take over as the main driver of UK asset prices.

“We suspect by the end of 2021, UK equity prices will have regained all their losses and higher interest rates will have contributed to 10-year gilt yields rising to about 2 per cent and the pound climbing to around US$1.40,” the consultancy said in a 15 May report.

Australian investors seeking exposure to UK stocks could consider the UK-focused BetaShares FTSE 100 ETF (ASX:F100), with holdings including alcoholic beverages giant Diageo, energy company Royal Dutch Shell and consumer goods company Unilever.

Another alternative is the Vanguard FTSE Europe Shares (ASX:VEQ), which while investing in major European markets had around a quarter of its funds invested in UK stocks as at 30 September.

In the meantime, ignoring the headlines and focusing on the fundamentals appears key for investors, as the Brexit saga continues to grip the nation.

is a Morningstar contributor.

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