I haven't talked about Brexit here for a while. I mean, that’s probably not a terrible disappointment to any of us. But as the year-end approaches, I thought I’d quickly check in on it all. And believe it or not, I’ve got some good news.
I have no insight into what's going to happen as regards the current round of Brexit negotiations. My rule of thumb when it comes to second-guessing human beings is to look for the path of least resistance and minimum short-term pain, because on average, that's the path people will choose (note the focus on “short-term” – human beings discount future discomfort at an incredibly high rate, particularly if it's pain that will end up being inflicted on other people). The tricky bit then is to work out which path that is.
The path of least resistance on Brexit is hard to make out
For central banking, it's always been easy. It's a binary choice really – tighten monetary conditions or loosen them. And cutting interest rates and printing more money will almost always be the path of least pain, right up until inflation is getting us to the wheelbarrows-for-wallets stage. With politicians, it's a bit harder. They have far more influences operating on them, and their incentives are a bit different. There's what voters want. Then there's what they think voters want. Then there's what they think their voting base wants. Then there's what their party wants. Then there's what their pals want. Then there's what their ego wants. And you can throw in power, sex, money and legacy, in roughly that order, as an overlay on that little lot.
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In my view, one of the smartest people writing about this just now is Helen Thomas of Blondemoney.co.uk. She makes the point I've tried to make above far more pithily: “The best political result can be far from what looks like the best economic result.” Even more importantly however, the key point is that Brexit is an ongoing process. The biggest risk, she argues, is a “fuzzy Brexit” – one where the negotiation process just keeps rolling along, with a series of “OK, we'll park that and hammer out the details later”-type agreements, with temporary compromises and ongoing returns to the table.
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The point is that this process doesn’t end as such. Even if you get something approaching “no deal”, then all that really means is that a return to the table will be on the cards at some point in the future. And all the while bearing in mind that the political calculus for the individuals involved will keep changing over time, with "distance to the next election" perhaps the biggest issue for most of them.
The UK is cheap however you want to look at it
So the bad news for anyone hoping that Brexit will disappear from the news forever, is that you're set to be disappointed. Rumbling on, with the occasional flare-up, is likely to be the “new normal”. However, there is good news for investors – and that's that it doesn't matter. There are two main reasons for this.
The longer that this has gone on for, the longer that companies have had to prepare. As a result, they're much more ready for potential disruption scenarios. So you reach a kind of equilibrium level of assumed disruption. Expectations on all fronts have been lowered – as you can see from markets. So if things go even a bit better than expected, you’re nicely placed for a rebound.
Secondly, and more importantly, UK equities are one of the few genuinely cheap assets out there right now. Put it this way – unlike with the US, you don’t have to invoke “low interest rates” or “this time it’s different” arguments to justify valuations of UK stock markets at their current levels. UK stocks are just plain cheap. As Vitali Kalesnik of US asset manager Research Affiliates points out, based on the cyclically-adjusted price/earnings ratio (still one of our favourite valuation measures) that “UK equities are priced cheaper than emerging market equities”.
Of course, lots of people have compared the UK to an emerging market in recent years, but, while that’s a fun line that will get you fulsome “likes” in some quarters, it’s also basically stupid. Fundamentally, the positive about emerging markets is that their economies promise rapid growth and development. The negative is that property rights tend to be insecure. You can’t realistically say either of those things about Britain. Anyway – the point is that the UK is cheap, and while some of this is to do with Brexit, it’s also got a lot to do with “industry composition representing largely traditional sectors that have been left behind in terms of valuations.”
With value making a comeback; vaccinations against Covid-19 being rolled out (and thus lockdowns on borrowed time, despite the Christmas controversy currently occupying the front pages); and the potential for more Brexit clarity in the next few weeks, then as Kalesnik says, “The UK equity market has an unrivalled implied forward-looking return-to-risk ratio.” Put more simply, “in the current low-/negative-yielding environment, it is a very attractive asset class."
We've looked at a number of ways to invest in UK assets via funds and individual stocks over the last few months, and there are more ideas in our Christmas double issue, out next week. Subscribe now if you don't already and you can get your first six issues free.
