Setting the scene
The formal start of negotiations around Britain’s withdrawal from the European Union – the triggering of Article 50 of the Lisbon Treaty – is a key staging point along the route to Brexit.
Prime minister Theresa May committed months ago to a date before the end of March 2017, so the equity markets have had plenty of time to price in its implications and the triggering of Article 50 itself on 29 March is likely to be something of a non-event, according to many commentators.
Indeed, Ian Forrest at the Share Centre suggests it’s quite possible that the markets ‘may see the triggering of Article 50 as a relatively good thing, as it means the formal process of negotiations can now start and the two-year countdown begins’.
However, the wider stage is fraught with huge uncertainties over the possible fallout once Article 50 is invoked. From the size of the UK’s exit payment to the row over a second referendum for Scotland – not to mention the likely hardline positions taken as negotiations over the terms of the divorce get under way – prospects for the coming two years and more of Brexit deal-making look anything but smooth.
Such uncertainty is seeping through into softening economic data for the UK. For example, February saw a marked fall in UK (PMI) manufacturing activity data after a strong December and January, despite other regions continuing to see upward momentum. Companies’ earnings growth also dropped back in January.
At the same time consumers are starting to feel the impact of rising inflation, now expected by the Bank of England to rise above 2% this spring. That’s also feeding through into a fall-off in consumer bullishness, as measured by data on confidence indicators, retail sales and consumer credit.
And that’s without looking beyond the UK’s shores to the implications of European elections and the threat of a rising tide of populism that could potentially break the European Union.
Against that, there are a number of more positive economic indicators globally: higher US growth, a stabilising Chinese economy, signs of improvement in Europe and Japan.
So what does it all mean for investors?
Until negotiations are actually being hammered out and we can assess the likelihood of a hard Brexit, it’s hard to say. But there are some pointers to bear in mind.
On the one hand, the bull run continues unabated. The FTSE 100 index is in record territory, at well over 7,400 at time of writing. Clearly investors are hanging on in there in the absence of obvious alternatives or a decisive reason to pull out of the markets.
Undoubtedly, the big fall guy is sterling. The pound has been taking the hits in terms of reactions to Brexit developments and it’s likely to remain the tool markets will use when it comes to expressing a view on how the Brexit negotiations are going and what triggering Article 50 will ultimately mean.
‘Sterling’s slide from $1.49 to barely $1.22 since the EU referendum vote has acted as a shock absorber for the UK economy, potentially helping exports become more competitive,’ says Russ Mould of broker AJBell.
The question is how much uncertainty has already been priced into sterling’s value. The trouble is that it’s very difficult to know how far current currency levels do take account of the enormous Brexit question mark hanging over the country.
Many analysts expect the coming months to see further falls, with a low of $1.15 predicted, for instance, by Kamal Sharma at Bank of America Merrill Lynch. But others, such as Capital Economics, believe it could fall further, perhaps as low as $1.05, as the likelihood of Britain exiting the EU without a deal in place gains traction.
So, as a starting point, which asset classes are most likely to prosper?
Fixed income: Although the traditional response to uncertainty has been to de-risk by buying bonds, it makes little sense in the current environment.
Ten-year gilts are still yielding only 1.25%, even after the sell-off from low near 0.5% last summer. That amounts to an investment loss in real terms if inflation is set to remain above 2% for the medium term, as the BoE predicts.
Equities: Unlike most bonds, stocks have the potential for inflation-beating growth and also higher dividend income payouts. Moreover, although the Brexit uncertainties hardly make for a climate of prosperity, there remain many fundamentally attractive, well-run businesses. Some are now expensive, but others are pretty cheap.
For canny stockpickers, the current politically driven dynamics provide interesting opportunities. Long-term investors may be able to pick up good investments to buy and hold, while traders can exploit short-term market movements on bad news or political tension – of which there’s likely to be plenty more.
So, on the assumption that the main consequence of Article 50 being triggered that can be identified at this stage is that sterling will likely weaken further, what routes are worth exploring?
