Market Analysis

About That Brexit Breakthrough

Another bit of Brexit-related uncertainty fades.

The UK and EU sort of reached an actual Brexit breakthrough Monday, agreeing on the length and terms of the post-Brexit transition period. Through December 2020, the UK will mostly still act like an EU member, following all relevant rules and participating in the single market. Between the official Brexit date and the transition period’s end, Britain won’t have a say on EU rulemaking, but it will get the green light to start signing its own trade deals. Both sides are hailing this as a big achievement, and indeed, progress is progress. So, huzzah! At the same time, what investors seem most concerned with is what happens after December 31, 2020, and progress on that front remains as glacial as ever. Yet it looks increasingly likely that whatever the final arrangement, investors and businesses will be able to begin planning for it well before it takes effect, helping markets gradually price in its eventual plusses and minuses.

 

According to the official Brexit timeline, UK and EU officials aim to wrap up Brexit talks late this year in order to give member-states sufficient time to ratify the deal by the UK’s March 2019 official departure date. So while the transition period is a bit shorter than UK Prime Minister Theresa May initially sought, simply having an agreement is positive, in our view—it lets the two sides move on and focus on the “end state” agreement that will govern the UK and EU’s relationship from 2021 onward. Haggling over the transition agreement for a few months would have delayed this more crucial process. Having more time will lower the likelihood of their rushing into a half-baked end state agreement.

 

Having the transition in place should also enable businesses and investors to start dealing with Brexit long before it becomes a reality. If the negotiation timetable sticks, there should be a two-ish year gap between the end state agreement and when it takes effect. While markets often dislike sudden sweeping change, they have historically been far more sanguine about seemingly big changes that take effect at a long delay. America’s Dodd-Frank financial reforms passed in 2010, but most of their provisions took effect over the next few years. US health insurance reform (The Affordable Care Act) passed that same year but didn’t take effect until 2013. These twin overhauls didn’t cause a bear market. They created winners and losers, but investors had time to get the lay of the land. Now, these are anecdotal examples, but what is Brexit if not a regulatory overhaul?

 

Another way to look at it: Markets generally dislike uncertainty. It discourages risk-taking—how do you make an investment for the longer-term future if you don’t know what the rules will be? As the end state agreement becomes more apparent, uncertainty should fade. Businesses and investors alike should have the information they need to get on with life. Knowing the rules will be X until December 31, 2020 and Y afterward is powerful! Even if firms don’t like Y, they get two years to figure out how to take those lemons and turn them into lemonade. They can discover the plusses as well as the minuses as they sift through the forthcoming changes and allocate capital and resources accordingly. Investors can do the same. As markets gradually discover some (or even many) of the potential unintended consequences before they take effect, it helps sap the negatives’ power.

 

Remember this as you read the inevitable hand-wringing over contentious issues like the Irish border, customs requirements, market access and other trade-related items. Sometimes just knowing the outcome is more important for markets than the outcome itself. Whatever they eventually agree on, markets should have ample time to digest it.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.