Happy New Year!
Just before Christmas, the UK and the European Union finally came to a deal on Brexit. I suggested you keep an eye on sterling to gauge the market reaction. Turns out that the pound was relatively cheery about the deal – no great fireworks either way. So what's in it, what does it mean for your investments, and does it mean we can stop banging on about Brexit for now?
Britain actually left the EU on 31 January last year. But from that point, we were in a transition period, which basically meant everything stayed the same. That transition period came to an end at the end of 2020, hence the deadline for agreeing a more permanent deal. That more permanent deal was finally arrived at, at the last minute, as all of these things are. That's how negotiating works. So what came out of it?
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There’s still a lot of talking to do on this Brexit deal
The main point is that there are no tariffs or quotas imposed on goods moving between the UK and the EU. So that stays the same. We do leave the Single Market and Customs Union, so customs checks are now required for goods crossing from the UK into the EU. We'll see how that pans out – there's no obvious disruption as yet, but traffic at this time of year is quieter anyway, even in the pre-Covid days.
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One big sticking point was the debate over the “level playing field” rules. In effect, Britain wants to be able to set its own rules on labour law, environmental standards and state aid. But the EU doesn't want it to veer too far from its rules. So the deal means that if either party feels the other is unfairly playing with the rules (ie, cutting standards or throwing around state subsidies to gain a competitive advantage), then they can impose tariffs.
As Alan Beattie has pointed out in the FT, for all the arguing, it’s unlikely that the UK “would even want to diverge a lot” on these three areas. Moreover, “the provisions are symmetrical” – in other words, the EU needs to be wary of how widely it might want to apply these rules in case Britain then counter-sues.
On fisheries – one big sticking point – there will be a five-and-a-half-year transition period, during which EU quotas will fall by 25%. Then there will be annual negotiations after that point. On other areas there’s still a lot of talking to do. There are the questions of data flows and financial services, which rather depend on the EU accepting UK data standards and financial regulation as being essentially equivalent to its own. From a practical point of view, this shouldn’t be an issue (after all, they haven’t changed from when we were a member state), but from a political point of view, it’s a different issue, particularly on financial services.
We'll have more on the precise details in MoneyWeek magazine later this week. But overall, how you see this deal probably boils down to how you feel about Brexit. Ardent Remainers won't be happy, ardent Leavers will probably be pleased to see that it's not membership in all but name, and most other people will probably just be glad that something was agreed. What's also very clear is that this is not the end of the conversation. Britain and the EU still need to hammer out lots of individual points.
But from a markets point of view, one thing is crucial: there is a deal. It might be a thin deal, but it does remove some of the “fat tail” outcomes – in other words, investors can stop worrying about low-probability but high-consequence events. Instead, Brexit becomes something that rumbles away quietly in the background, rather than a headline risk.
The UK market looks like a good catch-up play
So what does all of this mean for your investments? We've been pointing out for a while that British markets looked cheap, almost regardless of what happened with the Brexit deal. The fact that we've now reached one has to be a positive. It doesn't matter that this is just another step in an ongoing process. What does matter is that it helps to reduce the uncertainty even further. In turn, that makes it harder still to write off the UK as “uninvestable”, which has been the approach of global fund managers in recent years.
On top of that, when you look around the world right now, a lot of assets look expensive. Yet the new year has apparently not dented anyone's enthusiasm. We're in the midst of a bull market which is going to leave a lot of professional money managers feeling panicky about not being bullish enough. When that happens, investors cast about looking for “catch-up” assets. What hasn't done well so far? What can we invest in to make up for the fact that we missed the rally in that other asset class that we are supposed to be the experts in? How can we make up the gap between our benchmark and our own performance – and quickly?
That desperate race to find a money-making asset – and fast – is what leads to the lagging assets, which tend to be riskier or of lower quality than the leading assets, to make rapid gains once the main players in the sector have enjoyed their big rise. You can see it happening over in the crypto market. Suddenly, with bitcoin surging above $30,000 a pop, you can see the other cryptos getting a lot more attention. Ethereum – one of the other better-known ones – has leaped hard in the last week or so.
Well, the same thing happens in every other market. And I would suggest that the UK classifies as a decent catch-up play in the world of global equities. After all, the FTSE 100 index has just had its worst year since 2008, falling by 14%, according to the FT. That compares to a 16% gain for the US S&P 500, a 40% (!) gain for the Nasdaq, and a small but positive return for the MSCI Europe ex-UK index. So if you're looking for a rebound play, the UK has a dirty great “buy me” sticker slapped on its forehead.
Now that global fund managers can feel confident that the pound won't suddenly collapse overnight because of a big falling out with the EU, they'll feel happier about allocating money to the UK. More to the point perhaps, the UK no longer looks like the kind of thing that a grumpy client might balk at you owning. In fact, it looks more and more like the sort of faux contrarian bet that everyone ends up owning because it makes them look clever but doesn't actually involve much risk at this point in the bet.
In short, if your portfolio is low on UK equities, now doesn't look a bad time to own some. We'll have more on this topic in the next issue of MoneyWeek magazine, out on Friday. If you're not already a subscriber, get your new year off to a good start and get your first six issues free here.
