Brexit - the gift that keeps giving

James Penn
October 16, 2019

‘Brexit’ is truly the gift that keeps giving for anyone involved in article writing.

This writer has managed to fill last four articles with updates on the latest in ‘Brexit’, plus several others over the previous three years since the issue first arose. It seems that, each day, another ramification emerges, with yet another horrible, fascinating or compelling twist or turn. All endlessly readable… without repeating oneself.

On Friday (October 11th) we experienced another manifestation of this, with one of the most unusual and extraordinary days on the UK stock market in recent memory. There were large, divergent moves in stocks and sectors based purely on whether the stocks were seen by investors as ‘domestic’ (ie making the bulk of their revenues and profits from the UK), or ‘international’ (making the majority of their money overseas, and crucially in other currencies).

The former had a good day, the latter a bad one – markedly so. The underperformers (UK domestic stocks have underperformed the market over the past 12 months) outperformed, and the outperformers underperformed. ‘The first shall be last, and the last first.’

This was directly related to political risk, and the fact that the pound had its biggest two day move in ten years, rising to $1.26 on Friday versus the US Dollar, making those overseas Dollar denominated assets and earnings suddenly less valuable.

We last saw a rotation from ‘growth’ stocks to ‘value’ stocks in late August. The ‘value’ rally on that occasion lasted about three weeks to mid-September. This rotation could be even bigger, though it depends very much on agreeing that brexit deal with the EU.

The rotation on Friday was triggered by progress that UK Prime Minister Boris Johnson appears to have made on Thursday with the Irish Taoiseach, Leo Varadkar. This was a last ditch discussion that seemed doomed to failure, given what the Irish and the EU had said previously about the ‘backstop’ and the customs issue.

Yet it seems to have resulted in some sort of breakthrough, with Johnson reportedly permitting Northern Ireland to remain in the EU customs area (so that there will be no border checks), with limitations on any ‘Stormont block’. Whether the Democratic Unionist Party remains onside with the Conservatives, and in agreement with this, remains to be seen.

One guesses that this wholly unexpected development (I recall espousing to clients on Thursday that the most likely outcome was now ‘an extension and an acrimonious UK general election’) has caught a lot of investors off guard, and on the Friday this caused a lot of ‘short-covering’, or de-risking of positions.

Being short on the UK stock market, which means short selling stocks you think are going to go down in value, and in particular UK ‘domestic’ stocks, and short on pound Sterling has been a winning trade thus far this year. There may have been more people exposed to this than one had supposed. While a lot of ‘market neutral’ funds were known to be positioned this way, perhaps many speculators have been too.

Some individual ‘UK domestic’ stocks rose as much as 10% – not because they had just come out with outstanding, expectation-beating results – but purely because of those domicile and sourcing issues mentioned above.

So at the time of writing on Friday Royal Bank of Scotland, Marks & Spencer and Galliford Try were up 13-14% on the day, Bovis, Barratt, Persimmon, Lloyds, and Kingfisher were up 10-12%, and Easyjet, International Airlines Group (formerly BA), Legal & General, Royal Mail, Tui and ITV were up 7-9%. Meanwhile, Tesco, Barclays, BT, Sainsbury, Aviva, Morrison, United Utilities, Associated British Foods rose 5-6%.

All well-known names.

Twenty years ago, when the above stocks constituted a far greater proportion of the FTSE100’s aggregate value, moves like this would surely have pushed up the FTSE100 index itself up 2-3% on such a day. However, given their relative decline in value and importance over the past two decades at the expense of new listings and companies that have been successful in growing international earnings, the index was up just 40 points, or 0.5% on Friday.

The gains in these ‘UK domestic’ stocks were offset by falls in the value of the big pharmaceutical stocks, and a host of other companies like Diageo, Compass Group, Unilever and Reckitt Benkiser, which make the bulk of their profits abroad.

Poor old Neil Woodford, the well-known UK fund manager who has been having a hard time of it recently (due to an over-exposure to these self-same ‘UK domestic’ stocks, that has been well covered in the press), must have finally had a decent day.

Overall, this is an encouraging development, as any successful development on this front would avoid a hard Brexit, and avoid the prolonged uncertainty that another three month delay with a possible ‘cliff edge’ at the end of it would bring.

But it is early days yet. A week is a long time in politics.

The Brexit saga, and all the millions of column inches it has facilitated, may not be over yet!

Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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