The first day of trading in 2021 was positive for domestic equities after the UK secured a trade deal and the roll out of Covid vaccines continues, but this could be a short-term bump before uncertainty sets in over how the deal will play out.
The FTSE 100 rocketed by 3% in early trading on Monday before closing the day up 1.7% in reaction to Boris Johnson’s Christmas Eve “present” to the nation in the form of a deal with the EU. Monday also saw the UK become the first country to dish out the Oxford/Astrazeneca vaccine, weeks after the Pfizer/BioNTech jab was rolled out.
The All Share closed about 1.4% up while the FTSE 250 was more muted with a 0.2% gain.
Investment industry commentators think the trade deal is narrow, focusing on tariff- and quota-free trade in goods at the expense of services, but the fact it removes the cliff-edge of exiting the EU without a trading relationship for goods is to be welcomed.
‘Skinny, lightweight, the bare minimum’
At the time the deal was announced, Jupiter UK equities manager Richard Buxton described it as “skinny, lightweight, the bare minimum required… but a deal nevertheless”.
“This has to be good news for investors in UK equities and, after a very trying year, perhaps the best Christmas present many could have hoped for,” he added.
Legal and General Investment Management European economist Hetal Mehta says leaving the single market and customs union will introduce significant trade frictions and non-tariff barriers, which makes some disruption inevitable – but much less than in the event of no deal.
“Time will tell how much, and in what way, the UK chooses to diverge from EU regulations; the UK will probably face pressure to remain aligned to maintain market access and avoid a more ‘visible’ border with Northern Ireland down the Irish Sea,” she says.
UK economy could be £83bn better off with the deal
Mazars chief economist George Lagarias emphasises the importance of averting a no-deal, noting the Bank of England’s early estimates of the difference between a rudimentary Canada-style deal, which was ultimately achieved, and a no-deal Brexit are about £83bn.
“To put the number in context, at the beginning of 2020 the UK government was expected to borrow £55bn and ended up borrowing £394bn to combat the economic effects of Covid-19,” he says. “Adding another £83bn to that bill could be enough to break the economy for years to come.”
The deal has not caused LGIM to meaningfully change its domestic GDP outlook. Mehta says this is based on the belief that the difference between such a skinny deal and no deal in the coming year or so is relatively small. “That is notwithstanding short-term disruption, of which the agreement has reduced the likelihood and severity,” she adds.
But over the longer term, the picture could be different. Mehta says a deal that does not cover services and non-tariff barriers, but introduces trade frictions and hampers immigration etc, will probably erode the competitiveness of UK businesses and lower the domestic growth potential.
“As a reminder, many studies, and the government’s Brexit impact assessment (2018) suggest that in 15 years’ time, a free-trade agreement would reduce the level of GDP by about 5% versus staying in the EU.”
Mehta says the virus and vaccine developments are likely to dominate the growth outlook in the shorter term.
“The latest restrictions dent an already weakening recovery,” she says. “While the approval of the Astrazeneca vaccine is clearly good news, it’s difficult to have a high conviction on exactly when ‘normal’ levels of economic activity will return, given the intensity of the new virus strain.”
Only Russia and Brazil fared worse than the UK during 2020
Willis Owen head of personal investing Adrian Lowcock notes the UK stockmarket rallied on recent developments, including a vaccine breakthrough, agreeing a Brexit trade deal and the US’s $900bn in coronavirus stimulus spending. He also says investors also expect oil production to be cut as Russia and Opec meet, which is boosting the oil majors.
But, he adds: “Investors should temper any excitement in markets though, as today’s enthusiasm may not last. It is important to remember investing is for the long term, not a few good days, and markets don’t go up in straight line. The global economy faces many challenges even once the pandemic has passed.”
Columbia Threadneedle head of UK equities Richard Colwell notes only Russia and Brazil fared worse than the UK in 2020, yet UK equities are even cheaper than a year ago. He says international companies listed in the UK, pound-for-pound are on double discounts compared with if they were quoted in Europe or the US, and an average of a 40% discount to the World MSCI.
Colwell thinks Brexit is likely to result in short-term frictional trade costs, but sees the deal as a good outcome, removing a large part of the uncertainty that has weighed on UK equities in recent years.
“That the UK remains so unloved typifies the high levels of consensus thinking in markets. We continue to firmly believe in the UK, but trends often go on for longer than predicted. This creates the opportunity we see today, as it amplifies the impact when the switch in momentum finally occurs.”
He adds: “However, the window on unlocking this potential value is closing. While sentiment about the UK economy has been hurt by both Covid-19 and Brexit, the equity market does not need a great recovery to perform better.”
Modest rather than dramatic
As with the reaction to a vaccine breakthrough, Buxton foresees the most direct beneficiaries to be companies reliant on domestic economic activity such as retailers, housebuilders, selected leisure and financial companies while gains in multinationals will probably be more muted.
“Given the currency headwinds, it is likely they will rise, in the hope that global investors will once more regard the UK stock market as ‘investable’ rather than a pariah of uncertainty,” he adds.
But while a deal is “undoubtedly good news” for investors in the UK, Buxton expects reactions to be “modest rather than dramatic”.
“I expect overseas flows into UK stocks are likely to build slowly over time,” he says. “All too soon the focus will return to navigating this difficult virus-impacted winter, to partial lockdowns, rising unemployment and frustratingly slow progress towards mass vaccination and scalable testing.
“The UK finding its way out of the pandemic and its way in the world outside the EU will quickly fill the news pages emptied of stories about the trade negotiations.”
