LONDON, UK- With days to go, Brexit still remains a mystery

UK Prime Minister Boris Johnson has made it very clear via his public statements that Great Britain will be leaving the European Union, one way or another, at the end of this month.

Arguably, this statement is where any discernible clarity on the Brexit process ends. For many observers, developments since the June 2016 referendum on the decision to leave the EU has been mired in confusing jargon (i.e. the Irish “backstop”) and multiple failed attempts to reach a consensus in Parliament as to what form Brexit should take. Even with October 31 being around the corner, it would be hard to argue that meaningful clarity exists on the various options facing the UK’s exit and what their economic, financial market and political repercussions could be.

It is often repeated that what many investors dislike the most is “uncertainty”. That, in our view, is equally true for companies, especially when it comes to their capital investment decision making processes. When determining when or where to build their next factory, enter or exit a market, or buy or sell assets, these decisions must often be based on multi-year macroeconomic projections. The very confusing and politically charged atmosphere pervading the entire Brexit negotiations (or lack thereof) would reasonably make it difficult for any company to make forecasts with sufficient confidence. Therefore the natural response is to “wait and see” or even to say, “let’s not waste time with our investments and look beyond the UK”. Does the official data back up this assertion?

Indeed it does. The below chart shows that since the June 2016 referendum result, capital goods expenditure (capex) by UK firms has fallen sharply. Economic theory argues that the capex of today lays the foundation for the GDP and corporate earnings growth of tomorrow. Hence any declines in capex spending is a harbinger for less (or even negative) growth in the future, with negative implications for hiring, wages and ultimately, the general welfare of households and investors alike.

The one caveat to this dire outlook has been the marked depreciation of the British pound, which has made the UK a cheaper (and all else being equal, a more attractive) place for foreign investors to allocate their capital. According to UK government sources, net Foreign Direct Investment (FDI) into Great Britain actually surged from 2015 to 2017, the same time as the pound fell from 1.50 to 1.30 against the USD. In combination, what these two data series can tell us is that domestic firms are cautious on Brexit, but foreign investors might still be willing to buy UK assets; but at a more competitively valued sterling.

In our view, a weaker pound is not a panacea that will ‘solve’ the likely disruptions and higher costs of doing business in and with the UK, post-Brexit. Optimists argue that short-term shocks to Great Britain due to its divorce from the EU will be more than compensated for over the longer term, thanks to enhanced policy-making flexibility made possible by Brexit. We are less confident in this assertion, echoing more the sentiments of domestic UK firms that are holding back their capex plans. As is often said in many situations, the first thing an investor should do is look to what “the locals are doing” and take their cue accordingly. We remain cautious on the Pound sterling, even at current lower levels, pending greater clarity on precisely what kind of settlement is reached between the Johnson government and the European Union, on October 31 or beyond.

– Stefan Hofer, Chief Investment Strategist, LGT 

The information contained in this article has not been reviewed in the light of your individual circumstances and is for information purposes only. It does not purport to provide investment, legal, taxation, or other advice and should not be taken as such. No person should act or refrain from acting on the basis of the content of this article without seeking specific professional advice.

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