Ever since Germany released official data showing January imports from the UK plunged -56.2% y/y whilst exports bound for Britain dropped -29.0% y/y, we have seen numerous commentators argue these figures show how much the post-Brexit customs controls have damaged trade between the UK and Europe.[i] When the UK’s Office for National Statistics releases its own January trade figures on Friday morning, we think a similar chorus is likely to ensue. In advance, here is a discussion of why investors weighing Brexit’s market impact will likely benefit from taking these claims with a grain of salt.
Conceptually, using year-over-year trade figures to evaluate Brexit’s impact makes sense. Using month-over-month figures (the percentage change between December 2020 and January 2021) would invite skew since business surveys and other metrics show companies stockpiled goods and supplies before Brexit took effect. That activity seemingly boosted UK imports throughout 2020’s second half, as well as exports of most non-petroleum goods in Q4 2020.[ii] Even if Brexit went without a hiccup, we think trade activity quite likely would have fallen early in 2021 as businesses worked through these stockpiles. In theory, then, using the year-over-year calculation would be better because the base (January 2020) would similarly be a period when businesses were working through similar stockpiles amassed as an insurance policy against 2019 ending without an official Withdrawal Agreement.[iii]
However, January 2021 includes a large variable that wasn’t present in January 2020: the pandemic. In the various surveys on trade that we have reviewed, companies cite this as well as the new post-Brexit customs checks as reason for difficulty in filling overseas orders. That seems to us like a sensible assessment, and in our view, the impact of each variable is likely hard to disentangle. For one, the pandemic and associated lockdowns likely affected demand on both sides of the Channel. Since January 2020 predates this, it is a huge variable possible depressing year-over-year changes now. But beyond this direct effect, consider: Absent social distancing requirements, would better-staffed ports be able to process the new customs paperwork more quickly? We think there is a high likelihood the answer would be yes, but we also think it is impossible to quantify.
In our view, monthly calculations of year-over-year trade probably won’t be a useful way to glean Brexit’s impact until later this spring, when the year-ago reference point includes the effects of COVID policies. Considering the UK implemented most lockdown measures in late March 2020, making April 2020 the first full month affected by restrictions and social distancing requirements, we think it will be difficult to isolate Brexit as a variable impacting the year-over-year calculation until April 2021 at least. Even then, in the months that follow, there may be additional skew from the easing of restrictions after the first lockdown. So it may be difficult to draw firm conclusions, although all of this is unknown until the data emerge.
In the meantime, we think investors have a better way of gleaning whether Brexit’s impact on trade is a fundamental negative for UK markets. Our research shows—and a large body of financial scholarship concurs—that markets are forward-looking and efficient. That means that at any given moment, share prices generally reflect all widely known information and opinions and are looking further into the future. Therefore, in our view, an easy way to test whether a widely discussed issue is fundamentally problematic for shares is to see how shares have performed whilst it has been present. The post-Brexit customs regime took effect at midnight on New Year’s Day. So, if it were a deep problem for UK markets, it would be logical to expect UK shares to be performing worse than the world year-to-date.
As of market close on 10 March, however, that isn’t the case. The MSCI UK Investible Market Index (IMI), which (as its name implies) includes all accessible shares, has a higher return than the MSCI World Index, which encompasses the broad universe of shares in the developed world.[iv] Now, the UK market tilts heavily toward value-orientated shares, which are companies that tend to be more sensitive to economic changes and return more of their profits to shareholders rather than plough earnings into growth-orientated projects. Value shares have outperformed this year, which thus benefits UK markets. Yet the MSCI UK IMI Value Index is also outperforming the MSCI World Value Index year to date, which we interpret as further evidence Brexit trade hiccups aren’t a meaningful drag.[v]
Note that we don’t think value is likely to lead overall this year or for the foreseeable future, as the other conditions we think typically support extended value leadership aren’t in place. But in our view, UK shares’ recent leadership over the world—and UK value’s leadership over world value—during this period are the market’s way of signalling that they have moved beyond near-term Brexit headaches and are looking further ahead to an apparently brighter future.
[i] Source: German Federal Statistics Office (Destatis), as of 11/3/2021.
[ii] Source: FactSet, as of 11/3/2021.
[iv] Ibid. Statement based on MSCI UK IMI total return and MSCI World Index return with net dividends, both in GBP, 31/12/2020 – 10/3/2021.
[v] Ibid. Statement based on MSCI UK IMI Value total return and MSCI World Value Index return with net dividends, both in GBP, 31/12/2020 – 10/3/2021.
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