Confidence in scarce supply as Brexit uncertainty deepens

Thought of the day

by Chief Investment Office 12 Dec 2018

Whether UK Prime Minister Theresa May can secure parliamentary consent for the Brexit Withdrawal Agreement remains highly uncertain. She is facing a no-confidence vote triggered by members of her own party, along with EU unwillingness to modify the terms of the deal she previously negotiated.

May said that if she were to lose the vote, “The new leader wouldn’t have time to renegotiate the withdrawal agreement and get the legislation through parliament by 29 March, so one of their first acts would have to be extending or rescinding article 50, delaying or even stopping Brexit when people want us to get on with it.”

Currency markets have been unsettled by the increasing uncertainty. Implied volatility for three-month at-the-money EURGBP options, which has reached 13% from 6% in June, is the highest it's been since the June 2016 Brexit referendum. We expect currency volatility to remain elevated, but the impact on equities will vary based on foreign exchange (FX) exposure and scenario:

  • Companies with a great deal of exposure to the UK and sterling are more likely to do well under a successful deal scenario, as UK growth and sterling would likely rise.
  • Companies highly exposed to international revenues and non-sterling currencies are likely to outperform with a "no deal" or hard exit, as UK growth and sterling would likely fall.
  • The more domestically focused FTSE 250 should outperform under a deal scenario, while the more international FTSE 100 is likely to outperform if there is no deal.Given the uncertainty, we favor strategies that could perform in a range of outcomes and ones that take a more FX-neutral approach. Hedging currency risks, especially in the near term, still seems preferable. Income-seeking investors would do well, in our view, to invest in UK equities and follow a diversified dividend approach that offers exposure across a range of sectors and attempts a balance between domestic and international sales exposure. We believe the 5% dividend yield offered by the UK equity market is attractive, particularly relative to corporate and government bond yields that trend ever lower, with 10-year gilts yielding just 1.2% and UK investment grade corporate bonds only 2.9%.

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