Life after Brexit: “Soft Brexit” or a “Hard Brexit”?
The dust has begun to settle on the UK’s historic decision to exit the European Union (EU). Although there are many political and economic questions outstanding, our focus has shifted to the future negotiations, and whether we will have a “soft Brexit” or a “hard Brexit”.
In our view a soft Brexit would involve the UK negotiating a similar deal to Norway, retaining access to the single market, accepting the free movement of labour and continuing to contribute to the EU’s budget. A soft Brexit would likely have a minimal impact on UK economic growth; however, free movement of labour is likely to be unacceptable to the 52% of UK voters who voted to leave the EU.
A hard Brexit would be a much cleaner break with the EU, with the UK establishing a relationship with the EU on World Trade Organisation terms. The UK would lose access to the single market but it would no longer have to pay into the EU’s budget and would regain control of its immigration policy. We believe such a break would have a much bigger impact on UK economic growth.
With these possibilities—or something between the two poles—in mind, how might investors think about the post-Brexit investment landscape? For us, there are three key factors: UK monetary policy, currency and UK stock market.
We consider the prospect of slower growth in the UK is likely to prompt the Bank of England (BoE) into action later this year. We believe there is a chance of an interest rate cut from the BoE at its July meeting, and a chance of an additional cut by the end of the year. The sterling has already fallen, but the BoE’s actions, we believe, will likely weaken the currency even further.
A significantly weaker currency has ramifications for the money invested in the UK stock market. For the better part of a decade, many UK investment ‘active’ managers, who utilise research, forecasts, and their own judgment and experience to investment decisions on what securities to buy, hold and sell, have been invested in excess in domestic medium and small sized companies of the FTSE 250 whilst investing less so in the more international larger sized companies in the FTSE 100. We believe this has paid off, as between 2006 and 2015 the former has averaged 10.1% per year on a total return basis, while the latter has returned just 4.8%1. But, post-Brexit, the tide may turn. FTSE 100 companies source 75% of their revenues from overseas2, so a weaker pound will benefit large company names, rather than their small and medium sized peers. Furthermore, the potential slowdown in the UK economy is more likely to hurt medium and small sized names, with large cap firms benefiting from their international diversification.
Read more about J.P. Morgan Asset Management’s UK equity fund range:
For Professional Clients only – not for retail use or distribution. 1 FTSE, FactSet, J.P. Morgan Asset Management. Data as at 31 December 2015. 2 FactSet, J.P. Morgan Asset Management. Data as at 31 December 2015. Any forecasts, figures, opinions, statements of financial market trends or investment techniques and strategies expressed are unless otherwise stated, J.P. Morgan Asset Management’s own at the date of this document. They are considered to be reliable at the time of writing, may not necessarily be all-inclusive and are not guaranteed as to accuracy. The companies/securities above are shown for illustrative purposes only. Their inclusion should not be interpreted as a recommendation to buy or sell. J.P. Morgan Asset Management may or may not hold positions on behalf of its clients in any or all of the aforementioned securities. This material does not contain sufficient information to support an investment decision and investors should ensure that they obtain all available relevant information, including fund specific risk warnings, before making any investment. The value of investments and the income from them may fall as well as rise and investors may not get back the full amount invested. Issued by JPMorgan Asset Management Marketing Limited which is authorised and regulated in the UK by the Financial Conduct Authority, Registered in England No. 288553. Registered address: 25 Bank St, Canary Wharf, London E14 5JP. 0903c02a815207a1