- 02 February 2021
- 10 mins reading time
Were it not for last year’s historic pandemic-led economic slump, the implications of Brexit would be easier to discern. As it is, they have to be taken in the context of a broader set of influences.
The good news is that the three major factors driving the economic malaise in 2020 are gradually being ironed out: US political stability appears to have returned, vaccines are being distributed to combat Covid-19, and the UK and the EU have agreed a Brexit deal.
The Brexit agreement itself is limited in its remit, leaving observers to pass judgement according to their respective positions on trade and sovereignty. So let’s consider some of the implications for the UK in its new relationship with the EU.
Goods and services
Up to the end of 2020, the UK was a net exporter of services to the EU and a net importer of goods, as the following chart shows.
It was important to EU negotiators to demonstrate the advantages of remaining within the EU to its existing member states. One can argue that the Brexit deal has achieved this by protecting the EU’s trade surplus on goods with the UK, while removing the passporting that afforded smooth trade of services, the sector in which the UK had a trade surplus with the EU.
It must also be noted that UK negotiators wanted to be able to operate trade in services outside of EU regulations. So both sets of negotiators can claim victory of sorts on that score.
That lack of passporting is one of the elements of increased bureaucracy that businesses on both sides of the UK-EU trade deal now face.
Service providers have to match their counterparts’ services standards or reach a separate, mutual agreement (negotiation on this is set to continue) .
Physical goods travelling across the Channel, while tariff-free, are subject to customs and regulatory checks. They can no longer just board a ferry and set sail either to or from the EU.
Country of origin has to be proven. For example, Nissan cars manufactured in Sunderland have to be demonstrably manufactured in the UK, and not just assembled here. Otherwise tariffs could be applied on entry into the EU.
The increased volume of red tape was inevitable and should not come as a surprise. The challenge for businesses is adapting to their new administrative responsibilities inasmuch as they have been revealed to date.
Trade deals with other countries
The UK’s International Trade Secretary, Liz Truss, has signed 65 trade deals since the Brexit vote according to CityAM. However, 63 of those deals are rollover deals that are on the same trade terms as the UK had when it was in the EU. As the number of deals indicates, these include deals with non-EU member states.
The challenge now for Ms. Truss and her colleagues is to establish deals that replace the loss of trade with the EU that Brexit has brought.
According to CityAM, the country with which a UK trade deal is most likely to be announced next, is Australia. That’s due around Easter alongside a similar deal with New Zealand.
But the big fish is the US. It’s the world’s largest economy and the UK’s largest trading partner now that the UK has left the EU. President Biden will not be a soft negotiator though. He’ll be political compelled to assure voters who supported the “America first” slogan of his predecessor. And, as we touched on in our US election outcome webinar in November, the change of administration is likely to delay a US-UK deal by at least six months.
The UK economy needs trade deals sooner rather than later. As our Chief Investment Officer, Marcus Brookes observed in our Brexit webinar in January 2021, a no-deal Brexit outcome was seen by some as leading to a 6% drop in the size of the UK economy. The deal that we have is seen as an improvement, but still dealing 4% blow to the UK economy.
Our analysis suggests that UK investors have reason to be positive about the future.
The value of the pound sank sharply following the vote to leave the EU in June 2016. This reflected speculation that the UK economy would suffer. Since then, the value of the pound has recovered to a degree but still remains below the pre-Brexit level.
Meanwhile, the compounding factors of political upheaval (at home and abroad) and the severe effects of the pandemic have left UK stock prices largely lagging their international counterparts. The FTSE All Share Index, a measure of the value of publicly listed companies in the UK, fell by around 13% across the course of 2020, while the US benchmark stock index, the S&P 500, rose by around 15%.
What this means is that the value of both the pound and UK stocks appear to us to be under-priced. The value of the pound relative to other currencies could be set to rise over coming years as the UK’s trading position gets back on track, supporting UK economic output. At the same time, company profits could come back from their 2020 lows as the global economic environment improves and UK stock prices catch up with those of their overseas peers.
We don’t expect the same stocks that did well during the lockdown to continue their outperformance. Technology companies and food deliverers had a major boost as consumers turned to online and delivery services in 2020. We don’t expect all of that uplift in profits and stock prices for those companies to be permanent.
Rather, we are looking, largely in other industrial sectors. We’re focusing on companies that have good cash-flows, manageable debt and, quite possibly, fewer competitors in the post-pandemic world.
What’s more, fund managers that had been neglecting UK stocks because of the extra Brexit challenge, might now have to increase their allocations to UK stocks as prospects improve.
This, in itself, could help to boost UK stock prices and the value of the pound.
From a purely economic and financial perspective, last year was extremely difficult. However, our analysis suggests that the UK economy should grow at around 5% in 2021 and a further 4% in 2022. This is growth from a smaller base following the various challenges, but it is still substantial should it come to pass.
As a result, we are quite positive about the prospects for UK companies. The sting in the tail though, is the outlook for government bonds.
The investment community as a whole was buying huge volumes of low-risk rated bonds. Investors were buying them in order to reduce their exposure to falling stock prices, while central banks were buying bonds in order to pump cash into the financial system to help make lending cheap and easily available to businesses and households in financial stress.
As the situation becomes less turbulent, the demand for such bonds seems set to fall. And that would push their prices down. We still hold bonds in the appropriate portfolios that we manage because they serve a number of purposes, such as generating income and counter-balancing stock price falls. But we will not be surprised if some of the bonds we hold fall in price. That’s why we believe in a multi-asset strategy with a diversified portfolio of assets held over a long period of time.
And that last point has resonance with the Brexit situation. Our investment horizon is positioned for a period of around 10-years. This helps to reduce the effect of shorter-term turbulence such as has been caused by Brexit and the time needed bring the UK’s trading status back up to a more robust position.
Any views expressed are our in-house views as at the time of publishing.
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