David Cameron's political career may be remembered for various things, but chief amongst them will be his overseeing, as prime minister, of two constitutional referenda with the potential to transform the United Kingdom irreversibly - both of which he anticipated winning. In 2014, he granted Scotland leave to vote on independence from the rest of Great Britain, which was rejected by the Scots in a 55% to 45% majority. Then in the 2016 ‘Brexit’ referendum on the UK's continuing membership of the European Union (EU), voters opted 52% to 48% in favour of a departure.
Scotland, more Europhile than the English – voted by 62% to 38% to remain in the EU. The Scots also held elections in May 2021, in which the Scottish National Party (SNP) won 64 of the 129 seats in Scottish Parliament, one more than it won in 2016 but one short of a parliamentary majority, thus dimming the prospects of a second referendum in the near future. A victory in any second referendum would, however, leave the SNP confronting similar challenges to those currently being faced by Westminster: the myriad complexities of extricating an entire nation from an economic and political union without precipitating mayhem. Recent events in Northern Ireland, where the Brexit terms – specifically the creation of a border in the Irish sea in January to prevent goods 'leaking' from Britain into the EU – have rendered the country's politics even more febrile than normal, impeding trade between the two and bringing other niggles to the surface.
The impact on the UK stock market of Boris Johnson's eleventh hour 'no tariffs, no quotas' Brexit trade deal, delivered just seven days before the year-end deadline, is undoubtedly profound, both in the short-term and in the years ahead, given the thorny and multi-faceted nature of the issues. Cameron believed that the threat of economic and administrative disruption could secure victory. In one referendum, he was correct. In the other, his prescience proved to be awry and, whilst 'no deal' would undoubtedly have been a major blow – we've arguably ended up with the lesser of two evils – it's broadly accepted that Brexit presents deeper challenges for the UK than for the EU.
Thus, whilst an orderly and relatively pain-free departure is an obvious concern for the UK government – and indeed, to an extent, its electorate – it's one that is also vexing UK-focused asset managers such as Job Curtis, portfolio manager of The City of London Investment Trust. The trust within the Janus Henderson stable, invests predominantly in large cap, multi-national companies which populate the UK's FTSE 100 Index. Six months into a post-Brexit 2021, one is tempted to pause for reflection.
As Job points out in a recent episode of Trust TV, despite the fact that it applies only to goods and not services, December's trade deal removed an element that is universally abhorred by markets: uncertainty.
This uncertainty, largely a function of the glacial pace of Brexit negotiations, has seen UK shares unloved – and undervalued – for some time now relative to the other key world markets, with some investors spurning the UK stock market completely. Whilst markets have responded broadly positively to December's deal – the FTSE 100 is up just under 10% year-to-date1 – other factors have hindered progress. The established, blue-chip firms which make up the index tend to have a sizeable global footprint and run heavily internationalised operations – the mining and oil businesses would be obvious examples. Indeed, it's estimated that circa 70% of FTSE 100 company revenues are generated overseas2. An enthusiastic response to the trade deal saw a marked rise in sterling – to 1.18 against the euro in early April from a 12-month low of 1.08 in mid-September3 – which will have proved something of a headwind.
It's a little unsurprising, therefore, that the FTSE 250 Index of mid-cap companies has performed rather more strongly – up 12% year-to-date1 – being more reflective of the domestic market and thus less reliant on overseas revenues. The 'junior' index also comprises a greater number of businesses that are seen as recovery plays and are therefore well-positioned for the easing of lockdown restrictions, a significant release of pent-up consumer and corporate demand, and a resultant expansion of the economy.
Job makes reference to an obvious irony which is at play here. Having spent the best part of four and a half years inching towards an eventual exit from the EU, the UK's withdrawal largely coincided with the arrival of several highly effective COVID-19 vaccines and thus, with all the turmoil surrounding Brexit, its impact has been largely overshadowed by the anticipated speed of the UK's economic recovery. Global asset allocations have been underweight the UK for some time – it’s been the worst performing of any major market since 2016's referendum after all. However, now that the risk of a 'no deal' Brexit has receded, and the UK government's handling of the pandemic has taken a turn for the better, prospects for the UK market are improving. More specifically, on the basis that both government stimulus measures and the eventual release of pent-up consumer demand post-lockdown are likely to fuel inflation - which is widely seen as positive for value stocks, there is a view that we may finally see a significant re-rating of those much-maligned value holdings.
Identifying the sector winners and losers post-COVID is far from difficult: hospitality, 'bricks and mortar' retail, travel and leisure have been hit hard, for example, whilst e-tailing, streaming services, grocery retailing, healthcare and gambling have been clear beneficiaries. Job concedes, however, that identifying the sectors likely to flourish or flounder as a result of Brexit is a little harder, although newspaper columns have not been short of coverage regarding the unravelling mysteries of the post-Brexit border rules, now afflicting all movers of goods from car makers, to wine importers, to fishermen. However, given the various tailwinds, the prospects for a rebound in UK earnings growth are good as the economy re-opens, and recovering dividend yields should continue to support the domestic market, with few overseas regions offering anything comparable. For City of London, an investment trust strongly focused on delivering a reliable and rising level of dividend income, the outlook is decidedly encouraging.
Brexit is a process, not an event. It's early days, of course, and there are many aspects of the deal's implementation that have yet to be finalised. Boris Johnson is seemingly of the view – and he is not alone – that, over the longer term, loosening ties with a worryingly slow-growth continent and seeking opportunities both across the Atlantic and in the Far East will prove to be a better way of securing the UK's future economic prosperity. Having waited almost five years after the initial referendum for the departure terms to be finalised, we may not have to wait another five years to find out if Johnson is proved right.
1Source: FTSE Russell, FTSE 100 Factsheet, as at 31.05.21
2Source: The Guardian, 15.08.20
3Source: Morningstar, 10.09.20 and 02.04.21
Large capitalisation stocks (large caps) - Larger companies as defined by market capitalisation total market value of a company calculated by multiplying the number of shares in issue by the current price of the shares) tend to be easily bought or sold in the market (highly liquid).
Blue chip stocks - Stocks in a widely known, well-established, and financially stable company, with typically a long record of reliable and stable growth.
Dividend - A payment made by a company to its shareholders. The amount is variable, and is paid as a portion of the company’s profits.
Yield - The level of income on a security, typically expressed as a percentage rate. For equities, a common measure is the dividend yield, which divides recent dividend payments for each share by the share price. For a bond, this is calculated as the coupon payment divided by the current bond price.