The coronavirus crisis has shunted the Brexit into the background this year, and investors would be forgiven for feeling “Brexit fatigue” after discussing the topic for more than four years. But trade negotiations are taking on a new urgency as the December 31 deadline approaches. One way or another, there will be some sort of resolution, and that will have implications for UK shares, funds and sterling.
With market momentum positive amid vaccine hopes and a new US President, a deal with the EU could help investors reconsider UK equities after a bruising year. Still, a no-deal outcome could spur some additional volatility in the coming weeks: Bank of England Governor Andrew Bailey has warned that a no-deal Brexit would have a bigger impact than the Covid-19 crisis.
Will Flows Come Back?
Brexit isjust one factor why global fund managers are still underweight the UK when allocating assets. Combined with the weaker economy following Covid-19 and the dominance of value stocks in UK indices, the domestic market is perhaps justly unloved. Fund flows suggest investors in the UK are looking elsewhere, and at Morningstar.co.uk we are fans of diversifiying geographically anyway to avoid home bias.
But there is a chance that some sort of positive breakthrough could lead to a bounce in UK shares and sterling assets. Ben Whitmore, manager of the Gold-rated Jupiter UK Special Situations fund, sees early signs of a shift back to value stocks in November’s rally, and thinks only a small re-allocation of investor money to the UK would lead to a big rally. Nick Watson, a multi-asset portfolio manager for Janus Henderson, says there’s a “huge amount of catch-up potential” if investor money starts to flow back into the UK in the event of a Brexit deal.
This argument is backed up by the latest Schroders Adviser Survey, which shows there’s been a sea-change in how clients of financial advisers allocate to the UK: for the past 12 months, the vast majority of clients wanted to reduce their exposure to UK equities, but this has swung around in favour of increasing the weighting to the UK for the next 12 months (although around 40% are planning to keep their exposure the same).
Brexit Compromise
While UK fund managers have been arguing that domestic shares are undervalued and due a re-rating since 2016, investors haven’t yet bought into the argument. A swathe of dividend cuts this year from big names has made life even harder. “On a longer-term basis, the UK versus any other developed equity market is lowly valued on almost any metric,” says Laura Foll, a global equity income manager at Janus Henderson. But she says the pandemic has “increased the willingness to compromise” on Brexit, as the UK and Europe suffer the economic cost of coronavirus.
Since 2016, because of the weakness of the pound, large US-dollar earning companies have profited at the expense of domestically-focused companies. But in the event of a Brexit deal, sterling could rise and that may favour companies away from the FTSE 100 (over 20 years, the FTSE 250 has outperformed the blue-chip index, including and excluding dividends). And as many FTSE 100 firms aren't paying dividends, the time could be ripe for a mid-cap comeback? As our monthly dividend article reveals, there are a number of stocks outside the top flight paying a decent yield to investors.
Vaccine Hopes
Covid-19 and Brexit has been a toxic combination for UK domestic stocks such as banks, retailers, and those in the service sector. But if November’s rally is anything to go by, consumer-exposed stocks like pubs and transport firms could have the most to gain from a Brexit deal. A vaccine could also help Britain’s economy more than other countries, says Hugh Gimber, global market strategist at JPMorgan Asset Management: “The UK’s economy has lagged many other regions around the world over the summer, which creates the potential for a vaccine to have a larger economic impact if it helps to accelerate the return to more normal levels of activity.”
