Brexit’s Flurry of Headline Fears

According to the latest headlines, this week Jeremy Corbyn lured “Bremainer” Tory MPs away from Theresa May, the EU all but tried to annex Northern Ireland, and John Major potentially upended the entire Brexit process. At least, that is our attempt to reduce the media coverage of these major, complex news items into a simple and absurd soundbite for humourous purposes. All kidding aside, you would be forgiven for thinking these were watershed events with potentially huge implications for Brexit and its eventual impact on the UK economy and equity markets. Yet upon closer analysis, we believe none of these events represents a material shift from the status quo: Politicians are still creating noise, the big Brexit questions remain unsettled and the negotiation process remains slow and public, with plenty of daylight between both sides. In our view, this week’s developments shouldn’t prompt long-term investors to alter their opinion of UK equity markets.

Of the three events, we think Corbyn’s machinations may prove most significant in the end, but for now, we believe any forecast based on them would be speculative at best. When he announced Labour supported staying in the EU’s Single Market, some pro-EU Conservative MPs reportedly said they would cross party lines and vote with Labour against May’s plans to leave the customs union. Whilst the number of potential rebels is unclear, political analysts believe just 12 Tory MPs siding with Labour could result in a Commons defeat for May. This raised several questions about her ability to pass legislation (Brexit-related or otherwise) and the long-term viability of her minority government.

Yet political observers and investors have asked these same questions for months. It is well-known that May’s government is gridlocked. We think it has also long been apparent that political divisions would likely result in a watered-down Brexit resulting in little practical change from the extant relationship. As for the prospect of May’s government falling, this has been the subject of political and investor chatter for months. For all the headlines, Monday’s drama seems like more of the same.

Major’s intervention—in which he suggested MPs should have a free vote on the Brexit bill—also seems in step with the political environment since the Brexit referendum. Politicians from inside and outside the government have offered unsolicited advice and Brexit blueprints for nearly two years now. Very little of it has yet made its way into official policy proposals. Major’s speech gained widespread notice due to his stature as a former PM, but he isn’t in government. His stature doesn’t necessarily equate to greater influence, particularly when you consider that no single politician is likely to win mass converts. Pro-Remain people are probably naturally inclined to agree with Major, as most speculate a free vote would scupper Brexit, potentially forcing a second referendum. Pro-Leave people are unlikely to agree with him for the same reasons. His status as a former PM, on its own, seems insufficient to bridge the divide between those two camps.

The final item—the EU’s publication of a draft Brexit treaty that included a “backstop” scenario of Northern Ireland remaining in the customs union—seems like it should hardly rate as news, in our view. The EU simply put in words the broad verbal agreement reached by May and EU negotiators in December. Far from solving the Irish border issue, it laid out three possible scenarios, with the third (and failsafe) being keeping Northern Ireland in the customs union if they couldn’t agree to a bespoke deal. Based on our analysis of that deal, it seemed like that provision’s entire purpose was to foster more discussion and incentivise both sides to reach a mutually agreeable compromise. Debate over that compromise continued afterward and is still ongoing. May has stated her intent to avoid this backstop option for months, so her renewed opposition now seems like reaffirmation of a well-known opinion, not an earthshattering change. The Irish border issue was unsettled before Wednesday. It remains unsettled now.

Overall, we believe this week’s saga is most significant for the lesson it teaches: The Brexit story evolves too quickly for long-term investors to stress over any single development. By Wednesday, as we read through media coverage, it seemed headlines had already forgotten about Corbyn’s maneuver. As that day progressed, the discussion seemingly shifted from outrage over the EU’s draft treaty to anticipation for May’s own speech on the issue, scheduled for Friday. We wouldn’t be surprised if the story morphed several more times in the coming days. Yet in our observation, equity markets have a strong tendency to look past short-term noise and weigh long-term probabilities. Noise can influence sentiment, but for equity investors, we believe the key is to ask: Will any of this discussion meaningfully impact corporate profits two, three or more years from now? Actual policy changes can influence earnings, but nothing that happened this week amounted to policy set in stone. Nor, in our view, did it meaningfully affect the probability of various potential Brexit outcomes.

Therefore, we believe long-term investors would be wise to focus on what is likely to impact UK corporate profits over the foreseeable future: continued economic growth and burgeoning world trade, both of which should help boost UK firms’ revenues and earnings. Whilst politics and long-running fears have perhaps overshadowed these trends, we believe they should help benefit UK shares over the period ahead.