17 August 2018
By Alex Burn, Co-Fund Manager HC Verbatim Multi-Index Funds
The pound has continued its downward slide against major currencies recently as markets react to the possibility of a no-deal Brexit in March next year. With the UK currency falling to its lowest level in 2018 following a double attack of words from Mark Carney the Governor of the Bank of England (BoE); shortly followed by the UK trade secretary Liam Fox’s no deal Brexit remark. Both made the point to their respective audiences that there was an increasing chance that the UK could exit the European Union (EU) in March without an agreement in place.
This led to the pound dropping by almost 2% of its value against the dollar in one week and not even a positive growth estimate from the UK Office of National Statistics could reverse the downward descent. This weakness came only a few days after the BoE raised interest rates, only the second increase since the financial crisis – a move that many expected would push the pound upwards.
In a word, no. Sterling’s level versus other currencies is the probability that the market believes a no deal will materialise; so it acts as a barometer on news flow. We think that it is likely to remain pretty weak until we get the deal voted through parliament (UK parliament not the European parliament!) and we suspect that this could be at the last minute so potentially January or February next year.
It’s possible that it’s not all one way though with the potential for a relief rally if there is good news around the Northern Irish border situation or at least a plausible backstop plan to be put in place for a temporary customs arrangement.
We think that Mark Carney’s comment on the chance of a no deal being uncomfortably high was correct, but that he could have been a little more diplomatic. It is possible that rates were raised to prop up the currency with the bonus of having the freedom to cut rates if things go really bad. You could question why this didn’t happen when sterling first plummeted after the Brexit vote in June 2016 but then the impact on the economy was completely unknown.
We don’t think that this is the end of the situation and neither does the market. Do we think that a no-deal Brexit is priced in? We certainly believe that there is scope for the pound to drop some more....but now on specific news rather than posturing.
If there is a no deal Brexit then there’s the risk of contagion, and it won’t just be the UK that is affected, the Eurozone will also be impacted. This seems to be the one thing that all parties seem to agree on. That is Barnier, the chief Brexit negotiator for the EU, and the EU members, hard and soft Brexiteers – no-one wants a UK recession. Particularly as we remain one of the largest trading partners of the EU. The EU, taken as a whole is the UK's largest trading partner. Just to put a bit of colour on this, in 2016, seven EU member states recorded their largest trade surplus for goods with the United Kingdom, making it a highly significant trading partner within the single market.
At the moment our view is to be moderately underweight UK equities as we believe that UK equities have greatly benefited from a weaker sterling but the cyclical backdrop in the UK remains sluggish. We don’t think that the pound drop is dramatic enough to trigger a recommendation change in Architas’ house view strategy for investing in the UK.
Returns are too tied to political rhetoric and given the soon to be approaching Brexit deadlines and a number of important issues still outstanding; there is no appetite to change our position. However, we still think it’s beneficial to hold some assets with UK exposure, specifically, high quality equities which should offer protection in negative spells alongside managers which are able to take advantage of relevant opportunities and the volatility in the market and the currency. There is the possibility that we might trim the UK’s small-cap allocation as it has performed well and over the last few months have begun to drift. This is not as a result of any fundamental issues but given the currency and the propensity for drifting on lack of news.
The key word is still diversification, aiming to spread the risk of unexpected shocks to asset classes. If we see an increase in equity market volatility, holding a combination of bonds, equities and alternatives should provide protection to portfolios.
Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use.