- JP Morgan asset management’s chief market strategist for EMEA, Karen Ward, outlines what investors need to know ahead of the UK leaving the European Union on December 31.
- “At the moment this is the actual cliff edge, and I am not sure that understanding permeates the entire globe investor base,” Ward said.
- Ward breaks down why the FTSE 100 is “unloved” by investors and the further impact of Brexit on the UK market.
- “What I would say to clients is our core expectation is that we do get a deal, but we shouldn’t be complacent,” Ward said.
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This week could be “crunch week” for the British government to secure a Brexit deal with the European Union.
“We’ve got 10 more days, max,” said one UK official to a reporter at the Financial Times on November 15,
However, there is good reason to be skeptical on whether this really is the crunch point. Officials have provided deadlines before and worked past them, most recently with the October European Council meeting being touted as the official final deadline for a deal.
The UK left the European Union on January 31 and moved into an 11-month transition period to enable both parties to negotiate their future relationship on trade.
Now with just over a month until the UK officially leaves the European Union, on December 31, a deal is looking less certain, as the deadline to request an extension has already passed.
Brexit isn’t on every investor’s radar
Despite this uncertainty, client questions on Brexit this year are “absolutely minimal” compared to last year, said JP Morgan’s EMEA chief market strategist for its asset management division, Karen Ward.
“At the moment this is the actual cliff edge, and I am not sure that understanding permeates the entire globe investor base,” Ward said.
This year, Brexit has had to compete for investors’ attention amid a never-ending newsflow featuring the US election, rising coronavirus cases and national lockdowns. For global investors, who are less close to the situation, Ward thinks some may not realise that the UK is still in this transitional period where very little has changed and that true impact of leaving the European Union is still to be felt.
As a market strategist, it’s Ward’s job to remind clients about Brexit and its potential impact on investing strategies. However, she is concerned that by the time the dust settles on the US election coverage there will not be enough time for the wider global investor base to shift their focus.
The devil is in the deal-tail
Ultimately, Ward is telling clients to expect a deal and to focus on the breadth of any agreement.
With 80% confidence a deal will be secured, Ward believes the technical details will be the determinant of how disruptive Brexit will be, particularly the impact of regulation.
“What I would say to clients is our core expectation is that we do get a deal, but we shouldn’t be complacent,” Ward said.
The biggest uncertainty Ward foresees is timings with the “line in the sand continually moving.” She believes this will make it difficult for negotiators to know when to show their cards and when to compromise.
UK market impact
The main outlet for expressing views on Brexit has been via the pound over the last four years. And in the case of a no deal, Ward expects this volatility to continue.
This could be good news for the FTSE 100, which has more than three quarters of revenue coming from outside the UK. If the pound fell, then repatriated earnings could go up. However, Ward doesn’t think it will be as clear cut.
Brexit risks are already priced into the UK stock market to a large degree, Ward said. So a deal could just determine whether the market deteriorates further, or helps bring UK equities back into favor, she said.
In late October, the FTSE 100 hit its lowest in six months and in 2020 has generally underperformed other major indices, which has left many investors cautious about investing in UK stocks.
Domestic components, such as Brexit and COVID-19 cases, have played a part in the underperforming UK stock market. However, generally Ward thinks the lag is linked more to the sectoral split in the UK market, given that it is heavily weighted towards many of the COVID-19 “losers”, such as financials, materials and energy. She believes a movement toward global synchronized growth is what the UK market needs to make it attractive to investors again.
The ingredients for global synchronized growth are both a medical solution to COVID-19, a vaccine and/or rapid testing solutions, as well as ongoing stimulus from governments.
When society gets to a point of discussing global synchronized growth then this is when investors will be looking for the COVID-19 losers as a real return opportunity and the UK market will fit into that story quite nicely, Ward said.
In terms of preparing a UK portfolio for both the Brexit and COVID-19 newsflow, Ward is emphasising balance.
“For me getting clients to understand the starting point of how COVID-19 has created the winners and losers, and how that in turn on a sector basis has dictated style performance, which has dictated regional performance,” Ward said. “And just getting them to think about rebalancing across sectors, across styles, across regions, in case of when that narrative changes.”
In terms of the traditional 60/40 split between stock and bonds, for investors who are still looking for income and diversification while bond yield remains low, Ward is recommending looking at both macro funds and alternative assets such as real estate and infrastructure as options. However, she is cautions that they come with trade-offs.
Macro funds are mutual or hedge funds with strategies that base holdings on the political and economic views of various countries or on the fund’s own macroeconomic principles.
Macro funds are good at providing resilience against downside of stocks, Ward said.
Alternative assets, such as core real estate or infrastructure, have good diversification properties and have demonstrated more resilient income over the last five to 10 years, Ward said.
“Let’s just be mindful there is no free lunch,” Ward said. “So you’ve got to be accepting, if you’re subbing out some core bonds and you’re putting in some core infrastructure, you are then accepting less liquidity. So it’s thinking about different risk tolerance and not just volatility, but also liquidity and putting together an ideal portfolio that protects returns but at the same time, one that you are feeling comfortable with the volatility of your portfolio.”