Why the Brexit divorce deal is unlikely to boost UK stocks

Thought of the day

by Chief Investment Office 08 Dec 2017

The UK and the European Union have reached an agreement on the “Brexit divorce bill,” after overnight negotiations to resolve the Irish border question. The UK is expected to make payments of between EUR 40bn–60bn, and Prime Minister Theresa May has promised that there will be no hard border in Ireland.

The deal removes one level of uncertainty and clears the way for trade talks to begin, but we remain cautious on UK equities because:

  • The hard negotiations are just beginning. European Council President Donald Tusk said, “We all know that breaking up is hard, but breaking up and building a new relation is much harder.” The shape of the UK’s future trade relationship with the EU is a key factor for corporate earnings, and uncertainty is still clouding the outlook.
  • Stocks are no longer benefiting from a currency tailwind. Currency fluctuations have a big impact on UK stocks, as around three-quarters of FTSE 100 revenues come from overseas. Sterling has recovered from its 2016 lows, and we expect it to remain resilient. The pound’s valuation is cheap. Compared with current values of GBPUSD around 1.35, we estimate a purchasing power parity valuation of 1.59.
  • We expect global growth of 3.8% this year and 3.9% the next. The UK's more defensive sector make-up leaves it less leveraged to the global growth recovery than the Eurozone equity market.

So we continue to expect UK stocks to lag their European peers. The FTSE 100’s 0.7% underperformance versus the Euro Stoxx 50 on 8 December after the deal’s announcement is in line with this view. We still prefer Eurozone equities to UK stocks within Europe.

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