First glimpse at how stocks could react to positive Brexit deal
Investors were offered a window last Friday (11 Oct) into how an actual Brexit agreement might be received by the markets.
Many UK-focused companies saw double-digit share price gains including Royal Bank of Scotland (RBS) and Lloyds (LLOY), helping to fuel the biggest two-day rally for sterling in more than a decade and the best day on the FTSE 250 since 2016, all thanks to increased hopes of a Brexit deal.
The UK political situation remains febrile ahead of the 31 October date when the Government has pledged to complete Brexit – deal or no deal.
The big twist in recent days was the unexpectedly positive summit between prime minister Boris Johnson and his Irish counterpart Leo Varadkar (10 Oct) which paved the way for more intensive negotiations to start between the UK and EU ahead of the summit which starts today (17 Oct).
HOW DID THE POUND RESPOND TO BREXIT PROGRESS?
Having traded with sight of its recent lows after an apparently acrimonious phone call between Johnson and German chancellor Angela Merkel, sterling surged when a joint statement from Johnson and Varadkar identified a ‘pathway to a possible deal’.
The pound got another leg up when the EU gave the green light for Brexit talks to move to the crunch ‘tunnel’ phase. Between the morning of 10 October and the night of 11 October the currency moved 4% higher against the dollar – a huge move in the context of the foreign exchange markets. The pound was also substantially higher against the euro.
HOW DID STOCKS RESPOND TO BREXIT PROGRESS?
Companies with a domestic focus were the big winners in the wake of the ‘pathway’ statement. This meant the FTSE 250 index significantly outperformed the FTSE 100.
The strong pound undermined the relative value of the overseas earnings which account for around 70% of those generated by FTSE 100 constituents.
The table shows the best performers on the FTSE 350 between the market close on 9 October and 48 hours later on 11 October. It is not surprising to see several domestic-focused banks on the list as well as housebuilders and businesses with exposure to the UK construction sector.
Marks & Spencer (MKS) seems to have acted as a bit of a proxy for the UK high street and the benefits for the retail sector if a deal on Brexit is secured, bolstering consumer sentiment in time for the crucial festive period.
WHAT WOULD BE THE IMPACT OF A DEAL?
As we write some of the optimism over the chances of a deal has been punctured as talks appear to continue to founder on the issue of the Irish border. This after reports on 15 October the UK and EU were on the brink of a deal.
However, if an orderly exit from the EU is secured, some of the moves in UK assets we have seen in recent days could be made to look relatively modest.
UBS economist Dean Turner predicts sterling could hit $1.35 against the dollar if an agreement is secured, levels not seen since spring 2018. At the time of writing it was trading at $1.27.
WHAT WOULD BE THE IMPACT OF A DELAY?
Depending on how seriously investors are taking the threat of no deal there may be a small relief rally in domestic-facing stocks – such as housebuilders, construction stocks and banks – if a delay is forthcoming. The response may depend on whether the extension to Article 50 is to facilitate a general election or a second referendum.
The former seems more likely but the latter might be received more positively by the market as polling suggests a ‘remain’ outcome might prevail if put to a people’s vote.
Which comes first, an election or referendum, could be determined at a special ‘Super Saturday’ sitting of Parliament on 19 October, which is also the deadline for Boris Johnson to request an extension under the Benn act.
WHAT WOULD BE THE IMPACT OF NO DEAL?
Barclays has forecast that the euro could reach virtual parity with the pound in the event of a no deal Brexit with sterling predicted to hit a low of $1.10.
After the initial market shock, and the resulting knock to investor sentiment, this could see the FTSE 100 enjoy a similar rally to the one it enjoyed in the wake of the 2016 referendum as overseas earnings get a relative boost.
Head of multi-asset for Janus Henderson Paul O’Connor says: ‘UK assets will almost certainly rally further if Boris Johnson can get his deal approved this week, but, even in this unlikely scenario, celebrations have to be tempered by the recognition that this is a course to a fairly hard Brexit.
‘If the deal doesn’t pass, and the Brexit deadline is extended, then the outlook remains very hard to call. A large part of parliament wants a deal close to this one, and another part is campaigning for a second referendum, however there is no evidence of a majority for either.’