Saturday 24 August 2019

Unfolding Brexit mess leaves UK investors nowhere to hide

In the dark: The City of London is facing an anxious period as Brexit’s true form is yet to coalesce
In the dark: The City of London is facing an anxious period as Brexit’s true form is yet to coalesce

Elisa Martinuzzi

Bad news for investors living in the Greek tragedy that is Brexit: Theresa May's departure could merely be the end of Act One.

As new protagonists jostle for the role of UK prime minister, besieged UK traders are reluctant participants in the unfolding drama with the final script yet to be written. The climax could be everything from a crash out of the European bloc to a softer departure to a second referendum.

Valuations at multi-year lows are providing little solace for fund managers dusting off worst-case strategies as they weigh the heightened risk of a hard Brexit. They're fleeing domestic-oriented UK stocks in favour of exporters and relentlessly hedging pound exposures across the board.

"I've been in finance for nearly 30 years and this is the first time that politics is playing a much bigger role than the economy for a protracted period," said George Papamarkakis, the chief investment officer at North Asset Management.

He's resigned to more delays and sees a low chance a deal will come together by the next deadline of October 31. Like many of his peers, the investor has dumped UK stock holdings, and is long pound volatility.

Mr Papamarkakis isn't taking a directional view on the currency even after its almost 15pc plunge against the dollar since the June 2016 vote. Sterling, the worst G-10 performer this month, was little changed at $1.2652 in London on Wednesday.

Cross-asset managers are in existential limbo. Should they stay short sterling ahead of an economic slump? Buy beaten-up stocks? Or run a mile from UK assets with renewed vigour given the risk of a monumental rupture in the country's trading ties with the world?

These questions are hard to answer when political-guessing games dominate investment-bank research across the City and Wall Street - in place of analysis rooted in fundamentals like corporate earnings and monetary policy.

The polarization of UK politics reduces the scope for a compromise deal, or a softer Brexit, according to BNP Paribas strategists, who see a 40pc chance of no deal.

Similarly, Goldman Sachs assigns a 40pc possibility to the prospect the UK never leaves the bloc, a 45pc chance of Brexit with a withdrawal agreement, and 15pc of a crashing-out scenario.

The next lead actor enters the stage in late July, after Theresa May formally steps down as party leader. Brexiteer and former Foreign Secretary Boris Johnson is the favourite. Some European officials see him as an untrustworthy populist, the personification of a nightmare no-deal.

It's all leaving currency investors in a bind. While fundamentals suggest the pound is undervalued, whether the exchange rate can recover from its recent tumble toward post-referendum lows is anyone's guess.

A no-deal departure could send the pound sinking by around 10pc to $1.15, but so could investor nerves during the interlude, according to UBS Wealth Management.

Rabobank projects a "very strong chance that the next prime minister will be a Brexiteer" and increased chances of no deal with "downside risk for the pound". But it also sees a strong prospect of a divided Parliament scrapping an exit plan altogether come October, an outcome it says would be sterling-positive.

The hardening of political wills at the European Parliament elections - with big gains notched by both Nigel Farage's Brexit Party and the pro-EU Liberal Democrats - only adds to investor headaches.

The comeback of populist gadfly Mr Farage prompted Nicholas Wall at Merian Global Investors to reverse a long position on sterling a couple of weeks back.

"We closed our small GBP long when we saw how well the Brexit Party was polling, which clearly has the potential to drag the Tories towards a harder Brexit," the portfolio manager said. "Happy being neutral here.'

It's the same conundrum weighing on stock peers as valuations plummet anew. UK shares with the highest exposure to pound revenues have slid to the lowest since 2016 versus those with limited exposure, according to Cboe indexes.

"Stocks are cheap, but they could get a lot cheaper," Papamarkakis at North Asset said.

Amid the risk of a no-deal Brexit, Eaton Vance portfolio manager Ian Kirwan is snubbing domestic-oriented firms in favour of large-cap multi-nationals, an outperforming strategy since the 2016 vote. Yet, the US-China trade conflict is threatening to wipe out the benefit of a weaker sterling.

"There is no easy hiding place," he said.

Bloomberg

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