14th January 2019

BREXIT – What’s next?

On Tuesday15 January, the UK Parliament is to express its final position on the adoption or rejection of the new withdrawal agreement negotiated between Prime Minister Theresa May and the European Union.

The political nature of the issue makes it exceedingly difficult to predict the result of voting. Also, in the event that Parliament rejects the agreement, the law provides for a new ballot to be organised within 3 days of the rejection for the purpose of submitting a plan B. Beyond that time, the final deadline of 29 March 2019 sounds the death knell on the UK’s status as a Member State: if the UK and Brussels cannot reach agreement and no extension is requested, the scenario of a “hard Brexit” will come down like a hammer blow.

Against a backdrop of uncertainty that looks set to last, the markets are expecting Parliament to show its opposition.

In order to be completely objective when considering the issue, we need to stand back and study the following three scenarios:

The most optimistic scenario
The most optimistic scenario
In the first scenario, Theresa May succeeds in persuading Parliament and the result of Tuesday’s vote is positive. Acceptance of the new agreement lifts uncertainty on the Brexit outcome and allays investor fears, restoring their appetite for risk and the prestige of European equities.. The markets would clearly respond vigorously to this situation and at the same time, assets regarded as a safe haven, such as German government bonds, would drop in value.
The most pessimistic scenario
The most pessimistic scenario
In the second case, Parliament expresses its disagreement, and nothing is voted before 29 March 2019: the UK finds itself sucked into a downward spiral of leaving the European Union without an agreement. In other words, this is a “hard Brexit” - difficult to quantify the resulting economic and commercial repercussions. In contrast we could expect to see a disenchantment with UK equities, especially export stocks, that will obviously be affected, without however being alone in suffering from the knock-on effect of this situation, which will inevitably spread to other European stock exchanges. Against this backdrop, investors would lose their appetite for risk, rates would fall and pull down the sovereign bond market in their wake, not forgetting that European equities would suffer more than their US equivalents. A decision would therefore be called for: a return to quality investments.
Parliament says no and seeks to gain more time
Parliament says no and seeks to gain more time
Indeed, the law stipulates that the government has 3 days to indicate what it intends to do, which will probably involve asking for new negotiations in order to reach a better agreement. This scenario is the one that will give political leaders the opportunity to explain themselves and show their willingness to return once more to the negotiating table. In fact, the Labour party leader, Jeremy Corbyn, has already announced that he was not against this. For its part, the European Union should also show a more conciliatory approach, even if its credibility may suffer and it could find itself reproached for its lack of activity. In this case, if each side makes time its best ally, the European parliamentary elections would then be taking place during any such extensions: the UK would therefore be involved in the voting process which might well be an embarrassing situation. While this scenario has the merit of being less apocalyptic than the previous one, it deprives investors of a clear and well-defined outcome and, as a result, is likely to generate more uncertainty on the markets.

Similar to the turmoil in which the markets have been plunged over the past two years, such a stalemate could well fuel greater volatility. In addition, the UK would probably find itself on the road to another referendum on Brexit, the result of which would be no less uncertain. In practical terms, on European stock exchanges, equities in general and UK equities in particular would suffer from intensified volatility, pushing investors towards less risky assets.

Independently of the outcome of Brexit and the scenario that prevails, the allocation that we are using, which consists of remaining neutral on equities and bonds, is the best suited to prepare for any contingency.

Indeed, political decisions are difficult to predict and, with that in mind, an aggressive allocation would not be appropriate since it would be risky. As such, we will remain particularly attentive to the progress of forthcoming events so as to adapt our investments to the political decisions that will be put in place.