How to prepare your portfolio for a “bare-bones” Brexit


Note: since this article went to press, the prime minister has won the confidence vote by 200 to 117.

Theresa May’s political woes are grabbing headlines, but leave us no wiser as to which type of Brexit we’ll get, says John Stepek. So what would a no-deal Brexit mean for your money?

We were promised a big Brexit vote this week, and that’s what we got – just not the one we were expecting (see below). Yet whether or not Theresa May is still prime minister by the time you read this, it doesn’t make a huge difference to the three main potential Brexit outcomes facing Britain: we could get a massaged version of May’s deal; we might face a second referendum or a general election, both of which would probably mean delaying the 29 March deadline for Brexit; or we face some sort of “no-deal” Brexit.

The question for investors is this: what do these outcomes mean for your money, and what is already priced into markets? We know May’s deal would be a relief for markets for now – it maintains the status quo for the foreseeable future. The second option – yet more voting – would be a mixed bag.

Markets might like the idea that Brexit could be reversed, but they’d also fear the prospect of a Jeremy Corbyn government. However, when we’re wondering what’s priced in, it’s mainly the third option – “no-deal” Brexit – that we have to look at. What happens if no feasible alternative deal is put on the table and we still leave the European Union as planned on 29 March 2019?

We might end up with a “bare-bones” deal

It’s tricky to get clarity on what might happen in the event of a “no-deal” Brexit. Almost everyone involved has an interest in presenting either worst-case or best-case scenarios, both of which are unlikely extremes. What’s worth noting is that the most pessimistic outcomes – planes being grounded on 30 March, financial services migrating en masse into the arms of les gilets jaunes in Paris or the stolid suburbs of Frankfurt – seem overplayed. When it comes to areas where there is a very clear incentive for both sides to co-operate, we’ve already seen movement towards making sure no-deal compromises are in place.

For example, European traders will be able to continue using clearing houses in the UK to process derivatives trades. The EU is well aware that its banking system remains the most vulnerable in the developed world and the last thing it needs is the disruption, extra costs, and potential panic caused by a “disorderly unwind” in the derivatives market. As the Bank of England’s Jon Cunliffe, quoted in the Financial Times, put it to Parliament: “There are many in the EU… who recognise they rely on the UK for the scale and complexity of financial services they would not be able to replicate, or only be able to replicate at a higher price.”

Similarly, on air travel, compromise is being reached. The US has agreed a new “open skies” deal with the UK to allow flights between the two to continue after Brexit, while in a consultation note last month, the EU noted that, in effect, there are short-term measures that can be taken to prevent interruption of flights until longer-term solutions can be found. So we can already have some confidence in a “bare bones” Brexit (as Mark Littlewood of the Institute of Economic Affairs puts it).

How to profit from a “hard” no-deal Brexit

So what does this mean for investors? As we’ve already noted, the FTSE All Share is trading on its highest dividend yield since 2008. For income-starved investors – even in an era of rising inflation – that looks attractive.

What about more specific sectors? The area of biggest “no deal” vulnerability is probably logistics. In the long run, we will find solutions – companies will adjust – but in the short term there could well be disruption primarily due to “non-tariff trade barriers”, ie, more export/import admin. One beneficiary could be providers of warehouse space. Put simply, if supply chains lengthen as compliance with border controls becomes more cumbersome, then companies will require more storage space to get around this. That would be good news for providers of industrial property, because there simply isn’t enough of it.

As Nick Hughes points out in Property Week, “industrial space has struggled to keep up with demand since before the EU referendum” due to demand from online retailers. Estate agent Savills reports that vacancy rates nationally for industrial property are down to 5.8%. Warehousing specialists include the real-estate investment trust Tritax Big Box (LSE: BBOX), which has fallen sharply in the past six months.

It now trades at an 8%-or-so discount to its net asset value (having regularly traded at a premium over the last three years) and currently yields around 5%. Another interesting – if riskier-looking and rather illiquid – option on this front is Stenprop (LSE: STP). The group is in the process of shifting its portfolio (half of which is in the UK, with the other half mostly in Germany, and a bit in Switzerland) to focus on “multi-let warehouses” in the UK. It yields more than 6% and trades on a discount of more than 20%.

One risk is that industrial property becomes a bubble, where speculative developments explode and supply surges beyond demand. All it would take then is for a pin (in the form of a softer-than-expected Brexit) to pop the bubble. However, there are other potential beneficiaries from a shorter-term scramble for space and help with planning – logistics specialists.

One option is Wincanton (LSE: WIN). The group, which works with companies such as furniture giant Ikea, is trading on a forward price/earnings (p/e) ratio of 7.7 and offers a dividend yield of roughly 4%. Or there’s freight management business Xpediator (Aim: XPD), whose management believes that, as the FT reported last month, “its expertise in cross-border transport services, including customs clearances, leaves it well-placed to benefit from the consequences of Britain’s departure from the EU”. Xpediator is growing rapidly, trades on a p/e of 9.3, and yields 1%.


Is a second referendum on the cards?

As MoneyWeek went to press, Theresa May faced a vote of no confidence in her leadership, writes Emily Hohler. Support for May has been draining this week after she delayed  Tuesday’s “meaningful” vote on her Brexit deal in parliament when it became clear it faced certain defeat. If she wins the confidence vote (which requires backing from 159 Tory MPs), she will stay in office and cannot be challenged for another year.

If she loses, a leadership contest could take up to six weeks, which May has warned, risks delaying or even stopping Brexit, say George Parker, Henry Mance and Laura Hughes in the Financial  Times. Brexiteers believe May’s handling of Brexit, particularly the Northern Ireland backstop, has been disastrous, and are “willing to see Britain leave without a formal deal on 29 March”.  Yet as May says, a new leader would not alter the “fundamentals of negotiation or the parliamentary arithmetic”.  The House of Commons is “a primarily pro-European legislature, with many MPs warning they would attempt to block a no-deal exit”.

With or without May, there remains a seemingly “unbridgeable divide” between Brexiteers and remainers, as well as an “underlying conflict between our representative democracy and the direct democracy of the Brexit referendum”, says Rachel Sylvester in The Times. “Another referendum is the only way out.” The Brexiteers say it would constitute a betrayal, but nobody is suggesting the 2016 result be overturned – simply that people should be “asked whether they still want to leave now that it is clear what it means”.

Holding a referendum “will not be easy”, says pollster Peter Kellner in Prospect. For a start, it can’t be held before 29 March (the day Brexit is due to take effect), so the EU would need to agree to “delay our departure”. That issue should be surmountable. The trickier question is: “What kind of referendum should we hold?” Kellner lists seven options. These include a straight choice between remain and May’s deal; a two-stage referendum, first testing whether we really want to leave the EU, then giving us a choice between May’s deal and no deal; and a three-way choice, with voters stating their first and second preferences.

Of the seven, there are “probably only three in contention”, says James Blitz in the FT.  There is “some logic” to Kellner’s first option, but many Leave voters will view it as “too narrow, excluding the harder Brexit that they seek”, leading to mass abstentions and claims that the entire exercise is a sham. A three-way vote (May’s deal, no deal or remain) is broader but still problematic. The first and second preference system feels “complicated”, and putting “no deal” on the ballot paper – something a majority of MPs oppose – is “dangerous”, as it could win.

The third possibility is remain versus a Canada-style clean break, which covers a “much wider range of voter opinion” and is a straight two-way contest. But it feels too much like a “rerun” of 2016, and a win for the Canada-style option would “probably require an overhaul of the Article 50 treaty to remove the backstop arrangement”. In any case, we are still “some way from knowing whether a second referendum is a runner”. Much depends on whether Jeremy Corbyn and the Labour leadership decide to back it.

Labour is under pressure from within to do so, say Adam Bienkov and Adam Payne in Business Insider. But while the Labour for a People’s Vote campaign told BI that it believes backing a second referendum would “gift the party an additional 1.5 million votes and 70 seats at the next election”, some Corbyn advisers are “deeply sceptical” and fear that essentially telling supporters to “vote again until they give the right answer” could “trigger a wave of anger” towards the Labour party and its leader.

Yet a “re-run” of 2016, “only with the correct answer this time” is exactly what campaigners want, says Melanie McDonagh in The Spectator. But aside from the problem of the wording involved – People’s Vote proponents are very clear about remain being on the ballot, but not remotely clear about the alternative – Brexiteers are quite likely to “riot in the streets”.

They are, agrees John Lloyd on Reuters. If remainers get the result they want, the outcome could be the creation of a “large, angry populist party, probably of the right and perhaps also of the left”.  That would be very bad news for the UK, for Europe and for the cause of democracy generally. It would be seen, with some justice, as “they” crushing the democratic vote of “we the people”. Populism is on the rise, fuelled by a feeling that the “liberals and centrists have monopolised power for decades and have failed the people”. A reversal of the 2016 result “would generate class war”.


 

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