UK financial markets: Q4 update

James Penn
December 24, 2018

Recent political developments have made the job of forecasting outcomes for the UK economy, and UK financial markets, next to impossible.

One is reminded of the Schleswig Holstein question in the nineteenth century, a political conundrum so intractable that only three people understood the solution. One of them was dead, one had gone mad, and the other had forgotten. Given the impossibility of accurately forecasting what will happen (including whether there will be a recession next year, and the future of UK trade with Europe), it is not surprising that markets have sold off sharply since August.

More surprising is that the FTSE All Share has not materially underperformed other world markets. All major equity markets are off 8 to 10% in the quarter to date, amid an environment of poor investor sentiment. The period of ‘global synchronised growth’ that stock markets were enjoying only a year ago already looks a distant prospect. The FTSE100 index is once again sitting below the highs it reached at the end of 1999 (some 19 years ago!). While trade concerns have been churning away in the background since January, these have been exacerbated more recently by ‘peak earnings’ fears, whether this is the top of the economic cycle, and, of course, political risks.

The best that can be said of the latter is that the differences of opinion in Britain have so far resulted in deadlock or ‘fudge’, and haven’t been economically destabilising. In the wake of last week’s pulled vote on the Withdrawal Agreement, by my reckoning there are now eight possibilities ahead (Remaining in the EU, Leaving with No Deal, Passing Mrs May’s Deal, Norway Plus, Canada Plus, a Second Referendum, a change of Government, and a change of Prime Minister) all of which are perhaps equally likely. While it is hazardous to make predictions in the current environment, here’s my pennyworth about what may happen (no pun intended on the Prime Minister’s name) in the next few months.

Let’s suppose Mrs. May comes back to Parliament with virtually the same agreement (ie no concessions), then it’s almost certain to be voted down on or before January 21st, 2019. With the EU not budging, a slightly amended Agreement could get voted down again when it comes back to the House on or before February 11th. Suppose that Mrs. May (uncharacteristically, admittedly) then turns up the heat with a ‘We Must Begin to Make Preparations for Leaving with No Deal’ speech. We are now starting to run out of time.  Markets, and politicians – both here and in the EU – will start to get jittery. Given the EU’s proclivity for last minute deals and aversion to the disruption a disorderly Brexit would produce, it’s possible that in late March the EU caves in and permits a future termination of the Backstop, subject to technological improvements.

The UK could then leave the EU on amicable terms, and enter the Transition Period. Problem solved, and everyone breathes a sigh of relief. The only other alternative is surely an extension or withdrawal of Article 50 by the UK, ‘kicking the decision down the road’ – either until a Second Referendum, or a General Election in 2022, where political realignments may permit a vote on both a new Government and EU membership at the same time. In the meantime, the economy muddles along.

The stock market is likely to react with sporadic rallies and bouts of risk aversion, with investors likely favouring large, internationally diversified companies over UK domestics (which has been the recent trend). The UK stock market does look ‘cheap’ – particularly so when compared to those heady days in 1999. The yield on the FTSE All Share index now stands at 4.6%, with the Price to Earnings ratio at 12x, below long-term averages. There are plenty of bombed out, half decent, UK companies offering dividend yields of anything between 5 and 8%.

Thus far into December, there isn’t much evidence of festive cheer. But given that the UK’s political impasse has been delayed until late January, and given seasonal factors often come into play in December, there may be scope for stocks to rally a little over the next few weeks.

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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