A Brexit Trade Deal for Christmas

With one shopping day left, UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen just wrapped a last-minute Christmas present.

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In perhaps the least 2020 thing to happen all year, UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen agreed overnight on a post-Brexit trade deal. According to media reports we read, it took 24 hours of telephone haggling over fishing rights, which ended in an agreement whereby EU fishing boats can access UK waters for five-and-a-half years but the value of their catch must fall by 25%—a deal some on both sides will likely find lovely and loathsome. Oh, and trade between the UK and EU will remain tariff free and not subject to caps or other restrictions, a win for businesses on both sides, in our view. Now, we have long argued a deal isn’t necessary for both sides’ economies (or equity markets) to do fine once the post-Brexit transition period ends next week, so we don’t view this as some major positive or super-bullish catalyst for markets. But it does clear most remaining Brexit-related uncertainty, giving businesses clarity on trade costs. More broadly, it probably helps boost sentiment, which adds to the growing optimism as 2021 dawns.

Beyond the fishing bargain, the agreement offers little that wasn’t already expected. It puts the UK outside the EU’s customs union, giving it noteworthy freedom to diverge from EU regulatory standards—a key point for those who were pro-Brexit. As a result, there will be border checks on goods crossing the Channel and the Irish Sea, leaving the border between Ireland and Northern Ireland unfettered, consistent with the Good Friday Accord. Those checks could cause some near-term backups and delays as freight firms adapt to new paperwork and procedures—not dissimilar from the interruption France closing its borders tied to COVID response caused in recent days. Moreover, the deal doesn’t apply to services—including financial services, meaning UK-based firms need to have a physical EU presence to ensure market access. That said, this was widely expected—financial commentators we follow have discussed this for years and have reported widely that many firms have already established footholds in EU jurisdictions . It also remains possible that London-based banks gain access later if the sides reach an agreement on regulatory “equivalency” or thereabouts.

We should note, there is still room for this deal to, umm, flounder. Fishing rights are a very sensitive issue for both sides, which may make it difficult for von der Leyen to sell the deal to all 27 EU member-states—and for Johnson to secure Parliamentary ratification. However, we would be surprised if the opposition amounted to more than symbolic grandstanding, especially on the UK’s side. In our view, it seems just a bit of a stretch to imagine a few dozen members of Johnson’s Conservative Party banding against their leader to deliver their constituents a no-deal Brexit for New Year’s. We think that would be a very questionable political move, to put it mildly. We suspect similar calculations apply at the EU level, given the UK is a key export market for several EU nations. In our experience, politicians have a tendency of bending at the last minute to avoid disadvantaging their own constituents, lest they hurt their re-election chances.

So presuming the deal passes and goods trade across the English Channel remains free, most no-deal Brexit uncertainty has cleared up, which we think removes one long-running headwind from UK equities. The UK is the MSCI World Index’s worst-performing constituent country year to date, down -12.7% versus the world’s 11.9% rise.[i] In our view, a lot of lag stems from the UK’s heavy tilt toward value (equities that are more economically sensitive and concentrated in industries like Energy and Financials) and minimal Tech exposure.[ii] But the UK is also lagging the MSCI World Value Index, which we think is a decent indication of Brexit’s overhang on sentiment.[iii] With this cloud now lifting, we think the UK probably stands a much higher likelihood of performing more or less like global value, even if it keeps trailing the world overall.

Getting a Brexit trade deal probably also helps sentiment globally, as no-deal dread wasn’t solely a British or European phenomenon. It featured regularly in US headlines we follow as well. Now investors in Europe and America have one less thing to fear, which adds to the general sense of cheer we are noticing amongst financial commentators and forecasters we follow as 2020 ends. It wouldn’t shock us if warming sentiment were one of next year’s big themes.

In the meantime, we should reiterate, we don’t think anything that happened this week was hugely consequential for markets. Tariff-free trade is a small economic positive, but we don’t think the small tariffs that would have taken effect in a no-deal scenario would have derailed trade overall. Businesses are very good at absorbing these small costs, as we have seen in the US/China relationship over the last two-and-a-half years. In all likelihood, we suspect that as investors saw life go on mostly as usual post-Brexit, especially after being forced to deal early with chaos at the ports, uncertainty would have fallen and boosted markets. The only thing different now, in our view, is that instead of this being a gradual, almost subconscious realisation, investors get the good news all at once. Maybe it pulls returns forward a bit, but we doubt it has much effect beyond that.

Still, good news is good news, especially at the end of a year like this. So keep an eye out for any last-minute twists, but in the meantime, feel free to crack a smile or three.  

[i] Source: FactSet, as of 24/12/2020. MSCI UK and MSCI World Index returns with net dividends in pounds, 31/12/2019 – 23/12//2020.

[ii] Statement based on category breakdown of the MSCI UK IMI Index.

[iii] Source: FactSet, as of 24/12/2020. MSCI UK and MSCI World Value Index returns with net dividends in pounds, 31/12/2019 – 23/12/2020.

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