Knocking on the Brexit door

E*TRADE Securities2

06/22/17

Gobsmacked. In local parlance, that may be one way to describe the stunned reactions to the most recent general election in betting stations across the United Kingdom. In a land where placing a bet is as easy as grabbing a newspaper at the corner shop or a pint at the pub, bookmakers set the odds of Prime Minister Theresa May expanding her Conservative majority at nearly 80% prior to the snap election. But May’s call for an early ballot, which yielded a hung Parliament, was one political wager that did not come up aces.

In the crosshairs of May’s now weakened position is how Britain’s impending divorce from the European Union proceeds. Questions abound about whether May and the Conservatives have the political clout to deliver their preferred hard Brexit, or whether odds have shifted toward a softer breakup.

With political uncertainty ramped up and the already complex Brexit negotiations kicking off, we check in on the U.K.’s departure from the E.U. and potential investing implications.

Brexit means Brexit, maybe

May sent Britain to the polls three years ahead of schedule, in part to quell Brexit opposition in the House of Commons. Often quoted as saying, “Brexit means Brexit,”1 some believe the prime minister may have to soften that tone. The post-election London fog makes visibility difficult, but market observers can still sketch an outline of the two main Brexit scenarios:

  • Hard Brexit. A hard out could have the U.K. leaving the E.U. behind without negotiated agreements on the so-called Four Freedoms in E.U. membership: the free movement of goods, capital, services, and labor. Some view the positives to a hard Brexit as Britain not having to pay into the E.U.’s budget, being free of its rules and regulations, and setting its own immigration policy.   
  • Soft Brexit. A soft exit may include existing trade policies with the E.U. remaining in place. One option would be for the U.K. to negotiate a European Economic Area (EEA)-type relationship with the E.U., similar to Norway’s, where it participates in the single market without full-fledged membership. In this case, the U.K. would likely have to adhere to the E.U.’s immigration policies, pay into its budget, and comply with its rules, without having formal representation in future E.U. governance.

From a market perspective, the possibility of new tariffs and trade restrictions in a hard Brexit could be headwinds for large British companies that do significant business outside of the U.K. However, a weak sterling may help mitigate some of those hurdles for exporters as earnings are converted upon their return home. British retailers may not be as fortunate, as currency-driven inflation could dent their profitability. Also, airlines, notably budget carriers, have been vocal in their opposition to Brexit in general, given that it could complicate access to the continent.2

Some pundits say a softer Brexit may help keep intact London’s status as the world’s gateway to Europe, and dismiss thoughts (and costs) of corporate relocation, as well as the potential impact on commercial real estate. However, EEA-style membership would allow London to retain passporting rights, which give multinationals, particularly banks and financials, the ability to sell goods and services across the EEA bloc while only being regulated by one governing body.        

Keep calm and carry on

Sterling wobbled nearly 2% against the dollar in the aftermath of the poll results, though nothing like the 10% plunge following the E.U. Referendum. The investment community seemed to take the news from 10 Downing Street in stride, similar to how markets in the U.S. have reacted to 1600 Pennsylvania Avenue this year.3   

The 100 stocks that comprise Britain’s Financial Times Stock Exchange (FTSE) actually traded about 1% higher the day after the election, perhaps as investors continued to find attractive valuations from a group that has significant exposure to foreign markets. With nearly 70% of their revenues denominated in USD, the weak sterling has helped U.K. stocks; in fact, the FTSE 100 Index is up nearly 25% since the Brexit vote.4

Uncertainty is likely amid Brexit negotiations, and it could take years for the story to unfold. For investors, it’s important to keep in mind that the ebb and flow of negotiations may have little relevance on how the U.K. ultimately Brexits. Such an approach can help keep the news of the day in perspective when making investment decisions. 

  

Click here to login to your account or learn more about E*TRADE's trading platforms.  


1. Calamur, Krishnadev. “What ‘Brexit Means Brexit’ Means,” The Atlantic, 1 Jan. 2017 https://www.theatlantic.com/news/archive/2017/01/theresa-may-brexit/513314/

2. Jasper, Christopher; Katz, Benjamin D.; Johnson, Guy. “Ryanair, EasyJet Say Soft Brexit Won’t Ease Airline Concerns,” Bloomberg, 14 Jun. 2017. https://www.bloomberg.com/news/articles/2017-06-14/ryanair-easyjet-say-soft-brexit-won-t-address-airline-concerns

3. Kwok, Karen. “Why Did Markets Not React to ‘Shock’ Election Result,” Morningstar, 15 Jun. 2017. http://www.morningstar.co.uk/uk/news/159398/why-did-markets-not-react-to-%E2%80%98shock-election-result.aspx

4. As of June 15, 2017, according to https://markets.ft.com/data/indices/tearsheet/summary?s=FTSE:FSI. The Financial Times Stock Exchange, or FTSE 100 Index, consists of the 100 stocks listed on the London Stock Exchange with the highest market capitalization.