Wei Li, iShares EMEA Head of Investment Strategy
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Keep it brief
- With Brexit uncertainty continuing to weigh on the UK economy and showing no signs of abating in the run up to 31 October, we consider how investors can best position their portfolios.
- UK GDP registered its first quarterly contraction in seven years in Q2, while sentiment indicators point to ongoing contraction in the manufacturing sector.
- Investors have shied away from UK assets in the run up to Boris Johnson’s appointment as Prime Minister.
Brexit uncertainty has weighed on the UK economy since the 2016 referendum, when the public voted to leave the European Union (EU). This uncertainty has escalated in recent months following the resignation of former Prime Minister Theresa May, which triggered a leadership contest in the Conservative party and a lack of clarity over the government’s approach to Brexit. With the UK’s departure currently scheduled for 31 October, and the increasing likelihood of an economically disruptive ‘no-deal’ Brexit, we consider how investors can best position their portfolios amid this uncertainty.
The economic impact
Growth has been slowing in the UK, with the preliminary GDP figures pointing to a -0.2%1 contraction in Q2 of this year –the first quarterly drop in seven years. Sentiment indicators are showing a sustained contraction in the manufacturing sector, and the UK’s dominant services sector is stagnating. Our in-house GPS growth indicator points to room for downside surprise for UK growth, given muted business investment and a global industrial sector contraction.
Bright spots do remain, however: wage growth is rising at its fastest pace in more than a decade, while unemployment is at its lowest levels since the 19701 (3.9%). Inflation is close to the Bank of England’s (BoE) 2% target rate and a lack of inflationary pressures, alongside an uncertain Brexit outcome, means that the central bank is likely to proceed with caution. Brexit uncertainty has largely played out through sterling, which has proved to be increasingly volatile, and consistently more volatile than a basket of emerging market (EM) currencies (see chart 1).
Chart 1: Rolling 30-day volatility of GBP/USD vs. 30-day volatility of a basket of EM currencies
Source: BlackRock and Bloomberg, 14 August 2019
Sentiment towards UK assets
Global investors have shied away from UK assets since Q1, with UK equity flows drying up in the run up to Boris Johnson’s appointment as Prime Minister. Investors have preferred to tilt their UK exposure towards fixed income this year, with c.$500m2 added to globally listed UK fixed income exchange-traded products (ETPs) in each quarter of 2019. In contrast, UK equity buying was largely concentrated in Q1, before the initial 29 March Brexit deadline; the $1.9B added over this period was the largest quarterly inflow into UK equity ETPs. Since then, subsequent quarters have registered outflows of $252m and $106m respectively2. Among UK clients, we’ve seen a broad underweight to UK gilts and inflation linkers, with quite a high allocation to non-UK equity (14% in US and 8% in EM), which leaves portfolios exposed to currency volatility. In fact, FX risk is the second most prevalent risk within these portfolios†.
We set out four scenarios below that are still viable outcomes for Brexit, and have aligned them to be either triggering an upside reaction or downside reaction in assets from the perspective of a sterling or non-sterling denominated investor. These scenarios are not mutually exclusive.
- A further extension of Article 50 (potential upside as it is an extension of the status quo)
- A form of the Withdrawal Agreement passes in Parliament (potential upside as it is an orderly exit)
- No-deal exit (potential downside as the outlook is extremely uncertain)
- General election (potential downside as this creates more uncertainty)
1 Source: Office of National Statistics, August 2019
2 Source: BlackRock and Markit, 16 August 2019
† Source: BlackRock Portfolio Analysis and Solutions, August 2019. For more portfolio-specific insights, please contact BlackRock Portfolio Analysis and Solutions.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any financial instrument or product or to adopt any investment strategy.
