Fail, Britannia

 By Guest Blogger Doug Rowat

The United Kingdom is a mess.

Prior to the shocking 2016 Brexit vote, the UK economy was one of the fastest growing in the developed world, now it’s amongst the slowest. And, as the British government undertakes the exhaustive and granular work of actually figuring out what a Brexit will look like, things are getting worse.

The political crisis facing Prime Minister Theresa May picked up steam last month when two key cabinet members, Brexit Secretary David Davis and Foreign Secretary Boris Johnson, resigned, which is a bit like embarking on a Rolling Stones tour without Mick Jagger and Keith Richards. May herself has failed to clearly articulate to the public what a Brexit will look like and several polls now indicate that if there were a re-run of the 2016 referendum the ‘remain’ side would win easily.

The first problem, of course, is that May opposed Brexit in 2016, which probably makes her unmotivated to negotiate it now. Having to execute an agreement that you inherently know is going to weaken your country’s position in the world tends to sap your enthusiasm. Oddly, May can probably sympathize with Cleveland Cavaliers GM Koby Altman who had to try his best this summer to negotiate the LeBron James trade to the LA Lakers knowing that LeBron’s exit would doom his team next season. (Vegas odds of the Cavaliers winning the 2019 NBA Championship immediately dropped to 200/1.) Unlike Altman, however, May is not negotiating with just one league. She not only needs ratification from the British Parliament, but she also must receive the approval of countless other EU institutions and governments.

Much of the UK’s imports and exports pass through the Port of Dover, but even seemly straightforward tasks like hammering out new customs processes have become problematic. The New Yorker reports that

According to the Port of Dover, adding two minutes to the journey of every truck coming through the town will lead to a seventeen-mile traffic jam. [After roughly two years] since the Brexit vote…May’s government had still not settled on a plan for its new customs relationship with the E.U. The likeliest option, it is estimated, will cost businesses twenty billion pounds a year and take five years to develop.

In fact, during its 45 years in the EU, Britain has imported “around nineteen thousand European laws and regulations”, so every aspect of a Brexit becomes complex and, thus far, little progress has been made not only with trade logistics but also with tax, immigration, investment and military issues, putting the March 2019 deadline very much in jeopardy. It’s no surprise that a recent Sky News poll found that a whopping 78% of voters thought that May’s government was doing a bad job of negotiating the deal.

The New Yorker goes on to add that

The government’s own estimates show that every form of Brexit will make people worse off, ranging from a relatively modest impact, if the country ends up somehow entwined in the E.U.—and thereby less free—to a cost of around eight percent of G.D.P., if it leaves with no formal deal at all.

Clearly, the UK economy has suffered because of the Brexit overhang and will likely continue to suffer. This is one reason why consensus is forecasting only 1.3% economic growth for the region this year versus the 3.1% growth it recorded in 2014, for example.

So, shouldn’t the UK equity market have performed horribly throughout this debacle? Far from it. The FTSE 100 has rallied more than 14% annually, including dividends, since the Brexit vote and is up roughly 7% in the past year. Reasons for this are varied, but the Bank of England continuing its stimulus program, the oil price rallying almost 40% since the vote (remarkably the UK equity market has a 17% energy weighting, almost equaling Canada’s 20% weighting) and UK companies having globally diversified revenue streams (the average FTSE 100 member received only 38% of its revenue from the UK and Europe last fiscal year) have all overshadowed the UK economic risk and contributed to the FTSE’s rally.

FTSA 100 has largely shrugged off Brexit risk

Source: Bloomberg

So, while a region’s underlying economy has tremendous bearing on the outlook for its equity markets, it’s important to remember that it’s not the sole factor affecting market performance. Theresa May fiddling while Britain burns (or, perhaps more accurately, contemplating whether to even bother fiddling) is certainly not helpful for the UK economy, but it doesn’t in and of itself mean that UK equity markets will collapse.

So, UK investors take heart: it’s not always the economy, stupid.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.