Complex Made Simple

Opinion: British equities and turbulent political drama in Westminster

The UK is not exactly the darling de jour of global markets, but if the political risk can be reduced by a new Tory Prime Minister, then select British equities could provide 20% - 25% upside in 2H 2019.

The FTSE 250 index has derated from 15 times earnings to 11X since June 23 2016 Sterling has fallen from 1.50 to 1.27 since the referendum If the US dollar slips in 2H 2019, I expect sterling will be a natural beneficiary

Investing in UK equities or sterling was pure Chinese water torture in the first half of 2019 as the Brexit pantomime went from the sublime to the ridiculous. After three aborted EU trade deal plans and two extensions to the Brexit deadline, Prime Minister Theresa May finally resigned.

The Conservative Party now chooses its next leader, who automatically becomes Her Majesty’s First Lord of the Treasury and thus UK Prime Minister. The Tory MP’s must now choose between the former head boys of Eton and Charterhouse, both Oxford men, Boris was even a former president of the Oxford Union and a member of the Bullingdon Club, the lair of toff-twirpiness in the city of dreaming spires. I make no secret of my fondness for the Hon. Alexander Boris Pfeffel Johnson, former editor of the Spectator, Mayor of London and Foreign Secretary.

The Tory membership rightly believes that Boris will defeat Jeremy Corbyn in the general election. I concede Jeremy Hunt would be a more reliable, predictable Prime Minister.

Brexit uncertainty and political risk in Westminster has been a sword of Damocles hanging over UK equities and sterling. The FTSE 250 index has derated from 15 times earnings to 11X since June 23 2016. Sterling has fallen from 1.50 to 1.27 since the referendum.

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UK equities lagged the Europe Stoxx 600 indices in 2019, let alone the spectacular bull market on Wall Street. Even a France unnerved by the gilets jaunes threats to President Macron’s Presidency and an Italy ruled by the Five Star – Liga coalition outperformed British equities. Valuations are never a timing indicator or even a rationale to invest in any stock market. Yet I believe Cool Britannia is now cheap relative to its fundamentals and political risk. Boris Johnson is a political opportunist, not a political ideologue. He will swear a “do or die”. Brexit on October 31 to be anointed Prime Minister but will not commit financial suicide with a no deal Brexit, as the markets fear. His first state visit will be to Brussels to negotiate a deal with the EU and seek another extension of the October 31 deadline. Will the Brexiteers howl in protest? 

Flows into UK equities funds have begun to rise in June. Earnings updates were more positive than what market valuation metrics imply, though the City of London sell side analysts see no imminent earnings upgrade cycle. The China-US trade truce at Osaka is positive for British equities. Risk is definitely mispriced on the London Stock Exchange and low hanging fruit is available for the taking.

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If King Dollar slips in 2H 2019, I expect sterling will be a natural beneficiary, the reason I am long at 1.26 for a 1.32 (hope against hope!) strategic target. Sterling is grossly undervalued relative to its purchasing power parity and interest rate spreads against the US dollar. True, the UK is not exactly darling de jour of global markets but if the political risk can be reduced by a new Tory Prime Minister, then select British equities could provide 20% – 25% upside in 2H 2019. Note that strategic buyers have begun to make bids for UK companies. So I sit and wait for Boris to keep his rendezvous with destiny as Churchill did in 1940…

October 31, Halloween, is also Brexit D-Day for Britain. Will a no deal Brexit be an economic twilight zone for the UK, a prelude to steep tariffs, a collapse in sterling and a High Street recession. Not necessarily, though Jean-Claude Junker has ruled out any more deadline extension or material concessions. Sterling’s fall to two year lows was directly correlated to Boris Johnson’s political ascent, the champion of no deal Brexit and the great blond hope of the Tories.

It is unlikely that the EU will solve Westminster’s political Gordian knot by abolishing the Irish backstop. A Brexit under the aegis of WTO leaves the Irish border issue unresolved and undermines the Good Friday pact with Sinn Fein in 1998. Boris Johnson has no choice but to threaten to withdrew the £39 billion divorce settlement Mrs. May offered the EU in order to coax Brussels back to the negotiating table. Britain’s divorce settlement with the EU could be a source of bitter, protracted conflict between Downing Street and Brussels whose endgame could be a vote of no confidence against the Tory government in Westminster.

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As Edward Heath, Margaret Thatcher, Neville Chamberlain and Harold Macmillan learnt the hard way, the Conservative Party does not hesitate to commit regicide against its own political Mount Olympus. Of course, if a cabal of Remainers in the Commons bring down Johnson amid no deal Brexit, a general election and a potential loony left Labour government under Jeremy Corbyn could be the final act in the Brexit melodrama. “History begins as tragedy and ends in farce”, Karl Marx once observed.

Is no deal Brexit priced into the markets? Yes. Is Prime Minister Corbyn priced into the market? Absolutely not. So 2019 could be the year of three British Prime Ministers, as AD 69 was the year of three Roman emperors (apart from the hapless Nero). When history goes fast forward in Britain, financial markets go ballistic! So I wish Boris well and ask our friends to break into song – Jolly boating weather…

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