Brexit deal done, but investors may remain sceptical until dividends return and post-Brexit environment becomes clear

by | Jan 4, 2021

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George Lagarias, chief economist at Mazars, on three things investors should watch this week:

  • A last-minute Brexit deal may have averted an additional bill of over £80b to the already burdened UK economy
  • Investors, however, have largely remained put, due to lack of visibility as to how the deal will end up playing out in the next few months
  • We believe there is still potential for a positive re-rating of UK risk assets when more details are crystallised and possibly when dividends return to vogue

In dramatic fashion and featuring a high-stakes political gambit, a Brexit deal was concluded over Christmas, averting some of the worst consequences of a no-deal scenario. According to the Bank of England’s early projections, the difference between a rudimentary Canada-style deal, which was ultimately achieved, and a no-deal disruptive Brexit was about 4% in 2016 GDP, or £83b. To put the number in context, at the beginning of 2020 the UK government was expected to borrow £55b and ended up borrowing £394bn to combat the economic effects of Covid-19. Adding another £83b to that bill could be enough to break the economy for years to come.

However, from a purely economic standpoint we would revert to Winston Churchill’s famous Dunkirk quote: “we must be very careful not to assign this deliverance the attributes of a victory”. This is still a “Hard Brexit”, with many unknown variables as to how the complex divorce will work out.

 
 

For one, the blueprint of the EU – Canada deal is not necessarily pertinent. The EU accounts for 10% of Canada’s exports, mostly raw materials, and Canada accounts for 2% of the EU’s exports. Conversely, the numbers between the EU and the UK are 50% and 10% respectively, a lot of which involve services, signalling a much more complex and interdependent relationship. Secondly, “level playing field” clauses have the potential to disrupt the relationship for many years to come. To successfully compete, the UK may need to break from the current EU status quo, possibly inviting retaliation from the EU, depending on the prevailing internal winds. This would be a good time to remember that the 15-year Merkelian stability which has defined the EU may conceivably be coming to an end this year as the iconic Chancellor is set to step down. Ultimately, a lot will be decided on whether London will be able to keep its primacy as a global financial centre in the coming years, or whether European venues will be able, or willing, to compete successfully. Third, deals already signed, like the one with Japan, promise third parties a framework similar to the current one. And fourth, the UK’s own internal political backdrop seems to be in flux, rather than calming after the deal.

Meanwhile the Pound has been relatively steady versus the Euro, suggesting that this is the scenario that had been priced in, although this could change after the beginning of the year as traders return to their desks (the Pound’s two-year high vs the US Dollar mostly reflects the Greenback’s weakness which is trading near a 6-year low vs a basket of trade-weighted currencies).

With UK stocks remaining at relatively undervalued levels versus their global peers, the deal still has the potential to trigger an upward revision of risk assets, although we wouldn’t be too surprised if investors remained sceptical until dividends are in vogue again and until they have had a good look at what the post-Brexit environment looks like.

 
 

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