Analysis: Brexit trade deal sparks relief but UK market will bear scars

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© Reuters. People walk through the lobby of the London Stock Exchange in London

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By Tommy Wilkes

LONDON (Reuters) – Britain’s trade deal with the EU removes a 4-1 / 2-year fear of stepping out of the bloc with no trade arrangements in place, but it will take UK financial markets years to lose their Brexit-scarred scars.

The “no-deal Brexit” risk has weighed on Britain’s growth and investment prospects since June 2016, when citizens voted to sever ties with the country’s largest financial services customer, which accounts for $ 1 trillion in bilateral trade a year.

So Thursday’s appointment, seven days before the deadline, is an undoubted relief. Analysts are urging clients to rise in undervalued UK stocks, the worst result in any major market since 2016, and many say they have bought sterling, which is close to 2-1 / 2-year highs above $ 1.36. .

But those hoping the deal will allow UK assets to catch up with the high-flying overseas markets may be disappointed.

The naked nature of the agreement leaves Britain far more detached from the EU than was likely thought in 2016. Further negotiations are inevitable in 2021 to draft the agreement.

It all means that the rebate that has set UK assets since 2016 will not soon disappear.

“Brexit actually means that the UK is likely to lose some of its luster,” said Seema Shah, chief strategist at Principal Global Investors.

While the news could provide some traction to UK markets, it would not protect the economy from long-term scarring, inflicted by a combination of Brexit and COVID-19, she said.

“Being excluded from the world’s largest single market area will see jobs, people and capital flows drip away from the UK in search of destinations that instead embrace globalization,” Shah added.

Due to the discount, UK equities have underperformed since 2016 and delayed the global recovery since March, sending rival indices to record highs.

GRAPH: World stock indices since Brexit vote – https://fingfx.thomsonreuters.com/gfx/buzz/ygdvzjjayvw/Pasted%20image%201608813691856.png

The UK currency remains around 20% below its long-term fair value. Few expect it to recover fully in the short term.

The underperformance is largely driven by foreign investors dumping UK assets. Financial data provider eVestment estimates that European and US investors have drawn more money than they have added to UK equities almost every quarter between the referendum and the third 2020 quarter.

And because the size of the UK market has fallen as a percentage of the global index to 4% from 10% before the referendum, foreign investors no longer need to own that many UK stocks, said Caroline Simmons, CIO, UK, at UBS Global Wealth Management,

UK equities may do well given the other expensive markets – Simmons says UK equities are trading at a 30% discount over global markets at a typical 10% discount.

But she does not expect them to recover fully.

“As for the Brexit rebate, I think some of it will disappear, but will it disappear completely? The pull of cumulative GDP in the UK as a result of Brexit is still significant,” she said.

GRAPHIC: Sterlings Brexit discount – https://fingfx.thomsonreuters.com/gfx/mkt/dgkplqqkevb/brexit%20sterling%20valuations.PNG

COVID-19 CONNECTES BREXIT

As a further shadow of the outlook, the UK economy, already weakened by Brexit uncertainty, has suffered the worst damage in any major country due to the COVID-19 pandemic, with the second quarter of 2020 witnessing the worst recession in 300 years.

It has forced the government to raise its borrowing to a peacetime post.

Economic recovery is complicated by weak “bricks and mortar” direct foreign investment. The net value of foreign direct investment (FDI) to the UK fell to £ 49.3 billion in 2018, a quarter of the level in 2016, official data show.

This year, there will have been 30% -45% fewer FDI projects than 2019, estimates the consulting firm EY, mainly due to the pandemic.

Hinesh Patel, a portfolio manager at Quilter Investors, said the Brexit deal “could remove the blockade of international investment that has been waiting for some sort of result before institutions start investing in UK plc again.”

Others are less optimistic, saying the diluted ties with Brussels will inflict lasting damage.

“There’s a bit of short-term versus long-term history here,” Morgan Stanley (NYSE 🙂 head of cross-asset strategy Andrew Sheets said before announcing the deal.

Removing the no-deal risk raises average asset prices, Sheets said, but said: “It does not solve the underlying economic challenges … You are facing a negative shock to services that are a large majority of the UK economy. “





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