On 29 March, British Prime Minister Theresa May will officially trigger the start of the Brexit negotiations with the European Commission (EC). This will mark the UK’s second step towards divorce following the referendum on 23 June 2016. With or without an agreement, the British will cease to belong to the European Union (EU) by around the spring of 2019.
Opinions clearly differ widely as the negotiations begin. Europe wants to prevent the British from leaving easily or with an advantage. The EC is desperate to avoid anti-European politicians outside the UK seizing on Brexit as an example with which to push their own countries towards the exit. May, meanwhile, is under intense pressure to follow the will of the people without incurring too much economic damage. Yet no one stands to benefit from a shouting match. A sharp contraction in trade relations between the UK and the rest of Europe would be to both parties’ disadvantage. All the same, it would weigh more heavily on the island that sends over 40% of its exports to other European countries.
The clock is ticking, because two years to reach an agreement is tight. The EC wants a number of bills to be settled before a trade agreement can be negotiated. This is bound to generate a degree of tension, as the cost of the divorce settlement have been estimated at 60 billion euros.
Once Article 50 of the Lisbon Treaty has been triggered, there is no going back. Any lingering doubts – or hope – as to whether May would be willing or able (legally) to take the step will finally have disappeared.
The markets have been taking Brexit into account for some time now. The pound has already fallen 12% against the euro since the referendum. There is a remarkable lack of nerves on the part of investors, and news reports (unless they suggest a messy divorce) do not unleash a new wave of unrest, as the risk has been there for over a year now. Investors are currently ignoring the negative consequences of Brexit, as these will not be felt for the most part for another two years. In the meantime, of course, the UK continues to benefit from the single market. The financial markets are focusing more on the improving world economic picture.
Market reaction to yesterday’s announcement was restrained. Most stock exchanges are close to record levels. British ten-year benchmark bond yields are the same as at the beginning of the year. The pound keeps bumping along...
No adjustment to our strategy (*), but we remain vigilant
We have been concentrating for several months now on the improved economic growth prospects. Rising earnings once again and supportive central bank policy also argue in favour of a conducive investment climate. Our view of equities is therefore positive. Despite a number of substantial risks, which we will continue to track, the balance sheet is looking pretty positive. We therefore chose some weeks ago to overweight shares.
Within the equity component, we remain cautious about including British businesses. We prefer exchanges from the euro area. These are benefiting from more favourable economic prospects, expansive ECB policy and also a noteworthy increase in corporate earnings. Their valuation and dividend yield are also more attractive compared to US stocks. In a period of difficult negotiations to achieve an agreement between Europe and the UK, an increase in the value of sterling looks unlikely. We therefore maintain our negative view of the pound and are avoiding bonds denominated in this currency. If investor sentiment were to grow jittery, we would use the available cash holdings to take advantage of opportunities.
(*) The investment strategy described in this document relates to all investment funds (undertakings for collective investment) managed by KBC Asset Management NV, which make explicit reference in their investment policy, as laid out in the prospectus, to KBC Asset Management’s investment strategy. The stated strategy is not, therefore, altered in the case of other investment funds, the investment policy of which does not refer directly to KBC Asset Management’s investment strategy. It is possible that these investment funds are managed in a way that differs from the investment strategy. You should always read the prospectus and the Key Investor Information Document for the relevant investment fund.
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