Brexit progress: A ‘head in the microwave’ event
With the announcement that 'sufficient progress' has been made in the Brexit negotiations, Andrew Robbens, Client Portfolio Manager, looks at how this measures up to another unexpected event to have happened in the last 24 hours
I woke up this morning feeling a bit more positive about life. I had spent a very pleasant evening in the company of my father at a dinner and had started to feel a bit more in the festive spirit. As I started on my early commute and caught up with events from overnight, two things caught my eye that bolstered my mood even further.
Two incredible things have been reported this morning; both looked about as unlikely as each other to happen. The first news article that grabbed my attention was a Wolverhampton man cementing his head in a microwave. (Source: BBC News, 7 December 2017). A pretty unlikely event and I am happy to report that he was eventually freed by the Fire Service. The other event, that I thought was unlikely, was that the UK and the European Union (EU) would make sufficient progress in negotiations to move forward.
Like the man with his head stuck in a microwave, Brexit talks appeared stuck and, despite the efforts of many to free them up, no progress was being made. The Democratic Unionist Party had decided that the plan originally put forward did not represent a position that they were comfortable with, but overnight, after lengthy negotiations, a compromise has been reached.
There is certainly a palpable relief at the news that the Good Friday Agreement is being upheld. There will be no border between Northern Ireland and Ireland but the whole of the UK, including Northern Ireland, will leave the customs union and the EU single market. How this will work in practice is difficult to see but at least the basis of what each side believes is acceptable has been agreed.
Another crucial agreement regarding EU citizens’ rights has also been agreed ensuring that EU citizens currently in the UK and UK citizens currently in the EU will have the same rights after Brexit that they enjoy now. Perhaps this means that my Bulgarian wife will not need to become a British citizen after all!
This is far from the end. With time running out, there are many more complex issues to address such as how the UK and the EU will work together on defence, terror and foreign policy issues but, at long last, talks appear to be moving forward. Then there is the question of how the two parties will move forward on trade discussions. Although this is a significant moment for the negotiations, there is much more to do. Significantly, however, there does appear to be a willingness on both sides to build momentum in the talks.
So what does this mean for UK equities? Post the UK referendum, we have seen a negative correlation between the strength of the pound and the performance of the FTSE 100. This has generally been the reverse for the FTSE 250. There has been much talk, and focus, on the short term boost to companies generating revenues overseas if sterling weakens. This appeared to have subsided somewhat over recent weeks but today’s news has resulted in a modest boost to sterling which may be marginally negative for the earnings of many of the larger cap companies. It may also prove to be a slight headwind for exporters.
We must, however, put all of this into context. Sterling is still significantly weaker than it was pre-Brexit and, as a result, UK listed companies generating overseas earnings will continue to benefit. What is more concerning is where investors are focusing solely on the currency situation and not the strength of the underlying companies. Investors must not lose sight of the fact that the currency impact has been, in the short term, beneficial but a company must still be able to generate sustainable earnings growth.
J.P. Morgan Asset Management recently issued the 22nd annual edition of its Long-Term Capital Market Assumptions report (October 2017). The study suggests sterling is currently undervalued on a purchasing power parity basis with a level closer to 1.52 versus the US dollar more appropriate. Whilst sterling is up modestly on the news this morning (Source: Bloomberg, 8 December 2017), it still trades significantly below fair value on this basis and this will continue to benefit UK companies operating or selling overseas into the future.
The other fact to note is that the correlation of currency and performance of the different indices is not playing through today. Despite the strengthening of sterling this morning, optimism surrounding the progress in talks appears to have promulgated throughout the UK equity markets with all the main indices in positive territory (Source: London Stock Exchange, 8 December 2017).
I believe that the story remains the same as it has since the UK referendum, but with a slightly more upbeat backdrop. UK equities remain attractively valued, especially when compared to other developed equity markets, they continue to deliver an attractive dividend yield and continue to give investors exposure to the improving global economy. We will, no doubt, have more ‘head in the microwave’ events as we go through Brexit, but the latest breakthrough appears to be another happy ending.
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