As Theresa May meets European leaders seeking a better Brexit deal, the UK economy heads for a period of heightened uncertainty and stagflation.
Markets faced further uncertainty after the Prime Minister Theresa May began a series of European meetings in the hope of securing an improved deal on Brexit.
However, Jean-Claude Juncker, President of the European Commission, this morning warned that the current agreement was “the only deal possible”.
Mrs May yesterday postponed parliament’s “meaningful vote” on the government’s proposed Brexit deal, accepting that the deal would be “rejected by a significant margin”.
She will meet European leaders including Angela Merkel today before heading to Brussels for talks with Mr Juncker and Donald Tusk, the president of the European Council.
The pound fell by as much as 1.8% against the dollar on Monday, taking it to $1.255, its lowest level since April 2017. Sterling also slipped against the euro, edging close to the €1.10-mark.
The FTSE 100 index also fell yesterday, down 0.83%, even though UK stocks with international earnings normally benefit from falls in sterling. The FTSE 250, where fewer companies benefit from this effect, ended the day down 1.97%.
Gilt prices rose with the yield, which has an inverse relationship with price, falling seven basis points to 1.16%.
However, markets rallied this morning. By 4pm, the FTSE 100 was up by 102.3 points at 6,823.8, a rise of more than 1.5%.
Sterling had recovered some of yesterday’s falls, at $1.262 and €1.107 but demand remained weak. This weakness may explain some of the
Here’s what it might all mean from an economic and stockmarket point of view.
Keith Wade, Chief Economist at Schroders, said:
“Theresa May’s decision to pull the vote on her withdrawal deal from the EU means the UK now faces a prolonged period of uncertainty.
“The PM must get agreement from the EU on key changes to the deal in respect of the Irish border before going back to parliament. This will take time with talk of a vote in the new year.
“The deadline of March 29 will loom large and while the PM may use this to pressure MPs into accepting her deal rather than crashing out of the EU there will be more damage to the economy.
“Recent data shows the UK decelerating rapidly as firms and households put spending plans on hold. Yesterday’s events will only reinforce this trend, with the added problem of a weaker pound which will feed through into higher inflation.
“The UK is in for a dose of stagflation – when low economic growth combines with higher inflation – leaving the Bank of England in a dilemma over policy, but probably leaning towards a rate cut in the new year as the data reveals the weakness of activity.”
Issues for stock market investors to consider
The UK stock market has been increasingly shunned by international investors due to concerns about the unknown impact of Brexit negotiations.
Sue Noffke, Fund Manager at Schroders, UK Equities, said:
“While the deferral of the ‘meaningful vote’ raises further political uncertainty as to the path and eventual outcome of any Brexit deal, the valuation of the UK equity market reflects considerable negative sentiment.
“Global fund managers continue to underweight UK stocks, there have been substantial outflows from the market since the UK’s EU referendum and the UK stock market has seen a greater de-rating in the past two-and-a-half years compared to other equity markets.
“The UK equity market is not representative of the UK economy. The stock market is well diversified geographically, with just over one quarter of the revenues of the broad FTSE All Share Index derived from the UK economy. The balance of revenues, almost three quarters, are derived from overseas as a result of many multi-national companies being quoted on the UK index. The key factors dominating UK equity returns are therefore global economic activity, monetary policy globally and exchange rate movements rather than the performance of the UK domestic economy.
“Weakness in sterling against other currencies boosts revenues, profits, dividends and values (in sterling) of the significant component of international companies quoted in the UK. This is supportive for the UK equity market as a whole in the event of a no-deal Brexit (international investors would need to hedge their currency exposure).
“In such a scenario large oil, pharmaceutical, consumer goods and business services companies would do well. Conversely, domestically-exposed stocks might be set to benefit the most from any, more positive Brexit news flow – favouring domestic banks and financials, house builders, property and construction companies among others.
“The level of pessimism towards the UK stock market is apparent when comparing the dividend yield gap between UK and global equities. The UK stock market has historically offered a higher yield than other regions; however, the premium is now at its most elevated in almost 20 years, at a level not seen since the 1999/2000 dotcom bubble.
“The UK market now has considerably more stocks with a price to earnings valuation of less than 10x – the highest number (83) outside the global financial crisis. Meanwhile, the number of high-rated stocks (with a price to earnings valuation of over 20x) has reduced substantially from its peak two years ago (127) to 76 today. Most UK sectors are attractively valued relative to global peers. Indeed, there are good examples of both UK-focused and multinational companies based in the UK which are more lowly valued than their counterparts elsewhere.”
A price-to-earnings ratio, a measure of value, is calculated by dividing a company’s share price by its earnings per share over 12 months. The same calculation can be applied to a whole market. A low number represents better value. It is only one method of valuation used by investors. Past performance should not be considered a guide to future returns and may not be repeated.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors. Forecasts included should not be construed as advice or recommendation.
This article was previously published by Schroders on 11th December 2018