08th January 2019
2019 UK Market Outlook: Is it all About Brexit?
Chris Bailey, European Strategist, Raymond James Investment Services
“My whole outlook on life is, never judge a book by its cover” Floyd Mayweather, Jr.
Given his flawless record as a pugilist, Floyd Mayweather would seem like a perfect person to have on your side during troubled times. For UK investors in 2019, however, channelling his above quote will be prize enough.
Brexit – Where we’re at
Is there anything new that can be said about the Brexit debate? For many months now, important issues around the withdrawal of the UK from the European Union have dominated both the UK Parliament and the perceptions towards the UK financial markets. There is little surprise to this given the obvious importance in the precise definition of future trade relations with an economic bloc that directly and indirectly accounts for such a high proportion of UK trade. Despite this, there has still been a lack of sufficient political initiative to forge enough of a compromise to give clarity for businesses and consumers about the future structure of Brexit, with now less than three months to go before the key end of March 2019 decision point. Dynamically, this has necessarily cascaded concerns to all elements of the UK economy and financial markets, so that everything appears intimately linked with the Brexit debate. Modern economies are complex structures however, and in our varying roles as consumers, or possibly as industrialists/ entrepreneurs, we are subject to a variety of influences, even before we take account of the impact of government policy or the wider exogenous world.
Will common sense prevail?
At this point I could write that the spectre of the UK breaking away from the European Union does not seem likely. A clear majority – in both Parliament and in more recent general population voter polling – is in favour of a more compromise-style approach, or a ‘soft Brexit’ as it has been dubbed. A plausible outlook for the first few months of 2019 is lots of political noise, including talk about a second referendum or a general election and ultimately a thick slice of common sense to permeate the Brexit debate, quite possibly initially via a delay to the current Brexit timetable in order to quell the growth of uncertainty scenarios. And, logically, positive moves in this broad area would likely support both the British Pound and UK domestic financial assets after a difficult last couple of years, which has seen UK assets amongst the most disliked by global fund managers (relative to their asset allocation norms). As always, too much fear by shorter-term focused ‘voting machine’ investors leads to opportunities for more medium and longer-term oriented ‘weighing machine’ investors. Certainly, the current combination (versus recent history) of low valuations and high dividend yields in aggregate for the UK markets highlights some opportunity among all the threats.
Something akin to the above would be my central scenario for 2019. However – I would admit – there are some obvious potential challenges to this. Shorter-term political expediency could occur – including a change of government which could worry some in the business community – and ‘a clear majority’ can have their heads turned away from one scenario to another. Yet ‘muddling through’ still appears to me the most likely scenario in a situation where views are split on an issue which has morphed from a simplistic 2016 referendum question to a multiple shades of grey modern economic, social and political reality.
Wage inflation and interest rates
A ‘muddling through’ Brexit backdrop reality also starts to give weight to other drivers towards the UK economy and the UK financial markets. Consumption is typically two-thirds plus of a modern developed economy and the progress of real (i.e. after inflation) wages is unsurprisingly an important influence. The quiet rise in UK wages is both a push back against aggressive Brexit gloom and also a nod towards some skill and labour shortages in the UK economy. Clearly, any material wage pressure can be a burden on corporate profit and loss statements, but in the context of the UK economy in 2019, is more of a net positive than a negative. Additionally, the notion that the Bank of England is going to materially tighten policy in 2019 is clearly wide of the mark. In fact, caught between the inevitable Brexit uncertainty and a little bit of wage inflation, a policy of constant monitoring but no change in UK interest rates is very plausible. This is better news in avoiding serious issues for other important elements of the UK economy including corporate borrowing and the housing market and even the fixed income market (where yields however remain far lower than those available in the UK equity market). Additionally, 2019 is highly unlikely to see any contraction in the Bank of England’s quantitative easing boosted balance sheet, in contrast to the Federal Reserve policy in the United States, for example.
UK government policy should naturally be focused on minimising Brexit angst, but the recent UK Budget did indicate a loosening of the fiscal purse strings, which is a policy shift also apparent in many other countries around the world. As an economic contributor at the margin this is another plus.
Putting it all together, Brexit naturally dominates the UK economic and investment markets landscape but a combination of calmer heads and an effective ‘muddling through’ reality will encourage investors to rediscover UK assets instead of diving to hold more cash, as well as other influences on the UK economy including real wage growth and interest rate and fiscal policy trends. The real success story for the UK economy in 2019 may be that in a year’s time the word ‘Brexit’ will not be quite so omnipresent.
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