Brexit nears reality, but markets still unconvinced

Brexit was thrust back onto investors’ radar on Monday, with the British pound jumping as officials indicated that a transition agreement is coming together, but U. K. stocks failing to follow suit.

Negotiators said a deal has been reached on the 21- month transition period for the U. K.’s withdrawal from the European Union, although that won’t be binding until a final treaty is signed in the next year.

The transition is set to begin on Brexit Day — March 29, 2019, yet significant hurdles such as the status of Northern Ireland, still has market participants hesitating.

“An agreement will remove a significant uncertainty for British businesses as the U.K.’s formal break from the EU is due to occur in around a year’s time,” said Shaun Osborne, chief FX strategist at Scotiabank. “If Brexit terms can be formally agreed — issues like the Irish border arrangement may still prove tricky — sterling gains should extend somewhat.”

The pound climbed more than one per cent against the U. S. dollar on Monday, before giving up some of those gains later in the day. The currency also rallied as much as 0.84 per cent versus the euro, indicating that investors have confidence a transition deal is close to fruition. However, the U. K. equity benchmark FTSE 100 Index fell more than 1.7 per cent as the outlook for British companies remains hazy.

“This comes at a critical time just ahead of Thursday’s EC summit including EU leaders and U.K. Prime Minister May where parties are hoping to announce an agreement on the framework for the next stage of talks related to a future trade deal,” said Colin Cieszynski, chief market strategist at SIA Wealth Management. “It’s likely to be a busy week for U.K. markets."

In addition to the possibility of more Brexit news, investors will be watching the Bank of England meeting on Thursday closely. It remains unclear when governor Mark Carney will hike interest rates again, as the U.K. economy is showing signs of life, but continues to lag other major developed countries.

On Monday, the British Chambers of Commerce boosted its 2018 and 2019 GDP forecast for the U. K., but cautioned that it will be among the slowest growing G7 economies for the next few years.

With growth set to be stuck in the low to mid one per cent range for the next two years, and Brexit uncertainties casting a cloud over the economy and stocks, it comes as little surprise that investors don’t want to put money into the U.K. market.

The domestic equity market was deemed the least popular asset class in a Bank of America survey of 163 money managers in early March. Yet it was only a couple of months ago that U.K. stocks were achieving record highs.

The FTSE 100 hit an alltime peak on Jan. 12, but has dipped more than nine per cent since as an uncertain earnings outlook also weighs on stocks.

Sue Noffke, a fund manager at Schroders, believes concerns about the impact of Brexit are already priced into U.K. stocks.

“In share price terms, domestic companies started to underperform internationally focused U. K. companies in early 2016, as the EU referendum drew closer, and that trend strengthened after the vote,” she said in a commentary for Londonbased City A. M. “But since last November, the political background has grown a bit less discouraging and domestically focused shares have stabilized."

Noffke is favouring domestic U. K. stocks with the sterling gaining ground. She noted that the currency’s slide drove up the price of imports, and in turn, the rate of inflation. That was a primary reason why U. K.- focused business fell out of favour.

“Now a slightly stronger pound is helping to dampen price rises and make imports more affordable,” Noffke said.

The fund manager highlighted names like grocery giant Tesco, leading pet retailer Pets At Home, and bowling operator Hollywood Bowl.

With domestic- focused U. K. stocks trading at their biggest discount to exporters in nearly a decade, and close to the widest discount versus the broader U. K. equity market since the 2008-2009 financial crisis, they certainly look attractive. However, the “orderly withdrawal” from the EU officials are talking up with this latest deal, seems like a must if the tide is going to turn positively for U.K. stocks as a whole.

STRONGER POUND IS HELPING TO DAMPEN PRICE RISES.