18.04.2019  reading time: 5min

We anticipate four basic possible scenarios regarding Brexit:

1. An agreement has been reached on the withdrawal and it passes through the British Parliament;
2. A second referendum is less probable which results in a return to the Brexit status quo;
3. An agreement on the withdrawal was reached, but it does not guarantee Parliament’s consent or agreement on the withdrawal from the EU, and as a result the United Kingdom leaves the EU without a transitional period under the WTO terms of trade;
4. General elections, with the possibility of Jeremy Corbyn’s government.

Brexit creates three main threats for companies. The first is the disruption of trade: enterprises that have to move parts or finished goods across the UK border may be exposed to serious, if likely temporary, disruptions to the non-Brexit situation.

Currency risk is the second major problem. Many companies based in the UK have a global reach, and a relatively small business exposure to the British economy. As a result, their profits grow when the pound drops, which was visible after the 2016 referendum. Stock prices benefited from Brexit’s increasing anxiety. But recently, this dynamics has decreased, with some disturbing signals. Investors reduced both their share in pounds sterling and shares in large British companies when the risk of hard or chaotic Brexit increased.

The third risk is economic growth in the UK. In the worst case scenario, many forecasters believe that unreasonable Brexit could lead Britain to recession. And even if the final outcome is more lenient, continued uncertainty may lead to delays in investment and consumer confidence. Banks and consumer companies operating mainly in the UK are the most exposed to these threats. 

Investors must consider what will happen if a favorable Brexit agreement is reached or, if possible, what will happen if the UK stays in the EU. These results would probably benefit the British stocks by removing the uncertainty associated with Brexit, as well as cyclical European enterprises that have suffered losses as a result of the emergence of risk aversion among investors. Investors are waiting for a situation in which they are sure about the structure of their portfolios, ie, according to their assessment, the risk of Brexit inheritance is not overestimated, while the risk of potential increases related to the clear market environment is not underestimated. In fact, we believe that many companies whose business corresponds directly to Brexit now offer attractive return potential. Take, for example, Johnson Matthey, who manufactures car catalyst parts that enjoy growing demand as emissions standards become more stringent. Marks & Spencer, a seller of food, clothing and household goods, in which, in our opinion, the new management takes the necessary measures to assimilate the company’s operations with the new environment. Outside of Great Britain, Peugeot continues to reduce costs both in its former units and in enterprises that it acquired essentially for free from General Motors last year.

European challenges: populism, protests and parliamentary elections

Of course, Brexit is just one of the many political risks that are happening today in the EU. From street protests in France to governments in Hungary, in Poland, the resurgence of populism in Europe is a challenge for EU standards. In connection with the upcoming elections to the European Parliament in May, investors may fear further escalation of sentiments directed against the establishment, which may have a direct impact on the stability of the EU institutions.

In our opinion, these concerns are justified. The recent decision of the Italian government to comply with fiscal rules of the euro area, after an earlier example of Greece, suggests that populist rhetoric in the opposition, however, is giving way to pragmatism in the government: the overriding political order to stay in the euro has strong public support, as polls show.

Nevertheless, investors should look for hidden political risks that can have a real impact on corporate profits. In Spain, for example, recent tax changes introduced by the central coalition government have affected some of the banks, and the efforts to pass the budget this year will be complicated by the policy of Catalan separatism.

Political risk is not a reason to avoid European shares. Europe today offers many opportunities for bottom-up storage of stocks based on fundamental analysis, the key to investment success. But the thoughtful imposition of political risk analysis is essential to complement the picture and strengthen the belief in investing in these tense times. 

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all RCieSolution management teams. Are subject to revision over time.