Leaving EU behind: The potential winners and losers from a soft Brexit deal
After three failed votes, Prime Minister Theresa May has another six months to get her Brexit deal through the House of Commons.
Despite her securing an extension from the EU, the Brexit deadlock seems as intractable as ever. Still, some form of soft Brexit remains a likely option, so it’s worth exploring the potential impact on markets should a deal pass.
Short-term pain
The best guide for the outcome of a Brexit deal remains the immediate aftermath of the referendum in 2016.
Back then, we saw a sharp devaluation in the pound, and a seven to 10 per cent drop in the FTSE 100.
This was followed by an immediate rally, as the currency translation of overseas earnings worked its way through markets.
Such dramatic moves on the day are partly explained by the fact that the market had underestimated the possibility that Leave could win, and was therefore a bit too sanguine in the run-up.
Three years later, the likelihood of a soft Brexit is slowly working its way into the prices of the market, as can be seen from the rally in sterling from 1.26 against the dollar.
That being said, you can still expect a significant boost to the pound should some form of soft Brexit withdrawal agreement get over the line.
The last few months provided a clear demonstration of the interconnected fates of the pound and Brexit, with the British currency fluctuating against the dollar as MPs tried and failed to reach an agreement.
Any boost to the pound would immediately benefit British importers selling products to UK consumers.
Investors looking to capitalise on a sterling bounce would therefore be wise to focus on domestic-facing medium cap companies.
FTSE 250 manufacturing companies, for example, many of which rely on parts from China and Europe, should see their input costs go down, and therefore their profits would rise.
Two sides of the same coin
When it comes to UK equities, there are of course two sides to the Brexit story. Many investors are nervous about the impact of a surging pound on FTSE 100 companies with large overseas operations.
These large companies, 70 per cent of whose earnings come from foreign markets, would immediately see profits fall should the pound surge.
Global-facing British companies are particularly at risk, because overnight they could see their products become five, 10 or even 15 per cent more expensive for foreign buyers.
It’s likely that a soft Brexit could lead to market conditions that are similar to those immediately after the referendum: that is, a fall in
FTSE 100 stocks, followed by a rally – perhaps within the same day.
Taking refuge
Other stocks that could suffer in the event of a soft Brexit are the “bond proxies”: large utilities companies where investors take refuge in times of uncertainty.
As the Brexit clouds clear, demand for investments as safe as these will likely fall.
Something else to look out for post-Brexit is the impact of costly no-deal preparation.
British companies are stockpiling finished goods and raw materials as a defence against the possibility of supply chain issues resulting from a hard Brexit. This will need to be used up before the company is likely to buy new stock, and therefore whichever Brexit we see, UK economic growth is likely to sputter in the immediate aftermath as this stockpile is worked off.
Losing sight
It would seem, therefore, that the passing of a soft Brexit withdrawal agreement isn’t necessarily good news for all British companies.
However, to focus too much on the short-term impact of a soft Brexit on particular stocks and sectors is to risk losing sight of the fact that, broadly, it would be a net positive for the British economy.
When a country’s fate is clouded by uncertainty, investors tend to steer clear, while growth stalls.
A soft Brexit may lead to short-term pain. But over the long term, it is one of the more optimistic Brexit outcomes to come from the 2016 vote, particularly from an investment perspective.