Getting ready for a no-deal Brexit


We continue to prefer US over EU/UK equities on superior economic fundamentals and the breadth of companies that ride secular growth trends.
Chief Investment Office02 Sep 2019
Photo credit: AFP Photo


What happened?

Suspension of UK Parliament. With just a few weeks left till the UK leaves the European Union (EU), the newly-elected UK prime minister Boris Johnson has added an unexpected and controversial move to the Brexit saga – to suspend parliament.

The Brexit referendum has already claimed the tenures of two prime ministers. Pressure on Boris Johnson is mounting as 31 October, which marks both Brexit as well as the day Jean-Claude Juncker and Mario Draghi relinquish their roles as Presidents of the European Commission and the European Central Bank respectively, draws closer.The suspension will start on September 11 and the Parliament will be reopened on October 14 by a Queen’s speech, marking the longest suspension since 1945. Ironically, there are only two weeks standing in between the reopening and the last day to strike a deal.Up to now, UK corporate earnings have been helped two main factors: a weakening GBP and overseas income. The top-13 listed entities derive some 70% of their revenues from outside of UK/EU.

To date, UK corporate earnings have been supported by two main factors: a weakening GBP and increasing overseas income. The top-13 listed entities derive some 70% of their revenue from beyond the UK and EU.

At the going rate, a no-deal Brexit seems to be the default outcome – the EU and its 27 members have remained adamant about the UK leaving the trade bloc since the Referendum began in 2016. This could prove crippling to corporate earnings, household income, and the domestic economy which is already skirting near recession. A mismanaged situation could well see shortages in food, medical, and gasoline supplies; disruptions to seaports, airports, as well as cross border trades; and more importantly, further deteriorations to the already fragile pound.

What does this mean?

As detailed in CIO Insights 3Q19 and an earlier CIO Perspectives, we have been cautious on the UK situation since the start of the year.

We believe there will be further downside to the UK and EU:

  1. The prolonged feet-dragging of Brexit and the closing in of the 31 October deadline will further depress economic growth (Figure 3).
  2. UK prime minister Boris Johnson should think twice if he hopes domestic consumption will step in and rescue the situation (Figure 4).
  3. UK equities have vastly underperformed their US counterpart since Brexit began (Figure 5).
  4. Faced with trade tensions which are fast closing in on its exports and plagued with intensifying domestic issues, Eurozone overall is not looking good. In Italy, the formation of a new coalition between the opposing 5-Star Movement and Democratic Party may not offer the best solution, let alone the run-away budget deficit and high government debt holding stubbornly at 132% to its gross domestic product (Figure 6).

What should you do?

We have been constructive on US equities while staying cautious on the EU and UK since 3Q18. We further reiterated our stance at the start of 2019. Despite the huge gap of under-performance that has resulted in valuations that are at a steep discount to the US, we stay Underweight on EU/UK equities.

The much-anticipated potential reduction in the European Central Bank’s deposit facility announcement rate (now at -0.4%) is unlikely to help much in spurring the region’s growth. In addition, unlike the US market, we do not see the same breadth of companies that can ride the global secular growth trends of cloud computing and e-Commerce in the EU and UK.

The information published by DBS Bank Ltd. (company registration no.: 196800306E) (“DBS”) is for information only. It is based on information or opinions obtained from sources believed to be reliable (but which have not been independently verified by DBS, its related companies and affiliates (“DBS Group”)) and to the maximum extent permitted by law, DBS Group does not make any representation or warranty (express or implied) as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions and estimates are subject to change without notice. The publication and distribution of the information does not constitute nor does it imply any form of endorsement by DBS Group of any person, entity, services or products described or appearing in the information. Any past performance, projection, forecast or simulation of results is not necessarily indicative of the future or likely performance of any investment or securities. Foreign exchange transactions involve risks. You should note that fluctuations in foreign exchange rates may result in losses. You may wish to seek your own independent financial, tax, or legal advice or make such independent investigations as you consider necessary or appropriate.

The information published is not and does not constitute or form part of any offer, recommendation, invitation or solicitation to subscribe to or to enter into any transaction; nor is it calculated to invite, nor does it permit the making of offers to the public to subscribe to or enter into any transaction in any jurisdiction or country in which such offer, recommendation, invitation or solicitation is not authorised or to any person to whom it is unlawful to make such offer, recommendation, invitation or solicitation or where such offer, recommendation, invitation or solicitation would be contrary to law or regulation or which would subject DBS Group to any registration requirement within such jurisdiction or country, and should not be viewed as such. Without prejudice to the generality of the foregoing, the information, services or products described or appearing in the information are not specifically intended for or specifically targeted at the public in any specific jurisdiction.

The information is the property of DBS and is protected by applicable intellectual property laws. No reproduction, transmission, sale, distribution, publication, broadcast, circulation, modification, dissemination, or commercial exploitation such information in any manner (including electronic, print or other media now known or hereafter developed) is permitted.

DBS Group and its respective directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned and may also perform or seek to perform broking, investment banking and other banking or financial services to any persons or entities mentioned.

To the maximum extent permitted by law, DBS Group accepts no liability for any losses or damages (including direct, special, indirect, consequential, incidental or loss of profits) of any kind arising from or in connection with any reliance and/or use of the information (including any error, omission or misstatement, negligent or otherwise) or further communication, even if DBS Group has been advised of the possibility thereof.

The information is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. The information is distributed (a) in Singapore, by DBS Bank Ltd.; (b) in China, by DBS Bank (China) Ltd; (c) in Hong Kong, by DBS Bank (Hong Kong) Limited; (d) in Taiwan, by DBS Bank (Taiwan) Ltd; (e) in Indonesia, by PT DBS Indonesia; and (f) in India, by DBS Bank Ltd, Mumbai Branch.