12 months and counting……
We have now reached the halfway point between Article 50 being triggered and 29 March 2019, the date the UK will leave the EU. Both sides remain in negotiations, which may extend beyond ‘Brexit Day’, with a transition deal providing a grace period until the end of 2020, after which the UK is due to start trading with the European Union under new terms. At this juncture, it remains unclear what those new trade terms will look like. Looking forward, we can expect it to be a busy six months for both sides, with the European Union aiming to wrap up the details of a divorce deal by the end of October 2018, after which both the UK and EU parliaments will vote on the exit deal.
To date, the impact of Brexit uncertainty on the UK economy has been relatively muted, barring the impact on UK retail. The economy grew by 1.7% in 2017, and was deemed sufficiently strong to allow the Bank of England to raise interest rates in December. One area which has been very weak has been the UK high street, where declining household spending power (with wage growth failing to keep up with inflation) has weighed on consumer spending. The rise of online retail, along with regulation and pricing pressures has also played a key role. This does not look like improving any time soon, with the Bank of England warning on Wednesday that there is now “some evidence of financial distress in retail and leisure”. This is consistent with news from retailers themselves, with a number of high street names being placed into administration or undertaking significant store/restaurant closures, recent examples being Maplin, Toys ‘R’ Us, and Prezzo.
In capital markets, Brexit uncertainty is cited as a key reason why UK equities have been underperforming their international peers. Over the past 12 months, the FTSE 100 has underperformed the MSCI World ex UK by 9.9%. Data from Bank of America Merrill Lynch, who poll fund managers monthly on their asset allocations, indicates that asset allocators continue to have a low exposure to UK equities. This consensus has not impacted the currency though, with Sterling up 3.1% over the past 12 months (as measured by the Deutsche Bank GBP trade-weighted Index). The move against the US Dollar has been more pronounced, from $1.25 to $1.40.
The recent weakness leaves the FTSE 100 share index trading on a forward price earnings multiple of 13.2, its lowest level in four years, and a discount to MSCI World of around 17%. Arguably, therefore, a lot of the Brexit uncertainty is in UK based business share prices (i.e. the FTSE) rather than shares in UK plc (i.e. the £). There are clearly areas which look interesting to potential acquirers on valuation grounds, as evidenced by Japan’s Takeda Pharmaceutical’s potential interest in acquiring Shire PLC, reported this week, and also France’s Klepierre’s offer to acquire UK real estate company Hammerson.
The catalysts for a re-rating of the UK equity market could be any of a number of factors, including progress on Brexit talks, particularly around future trading terms with the European Union, an improvement in domestic economic growth, and robust global growth, given the high dependency on overseas markets for many of the companies residing in the FTSE 100. We will be watching carefully for signs that the clouds sitting over UK assets may start to clear as we move through the year.