Two and a half years on from the original EU referendum vote and 10 weeks away from the 29th March Brexit deadline, the House of Commons delivered a blow to the government’s Brexit plans on Tuesday, with MPs voting overwhelmingly against the proposed Brexit deal. The Prime Minister’s deal was defeated by 230 votes (by 432 to 202), representing the worst parliamentary defeat on record. Consequently, with only 71 days to go until the UK’s exit from the European Union, we are still no clearer on the ultimate Brexit outcome, and the future of the UK economy remains in the hands of negotiators in parliament and in Brussels. The crushing defeat of Theresa May’s Brexit deal on Tuesday night came as no surprise as it became clear in recent weeks that a lack of support for the deal in parliament would act as a brick wall to Brexit negotiations. Shortly following the vote, leader of the opposition Jeremy Corbyn tabled a vote of no confidence in the government which took place last night. As expected, the government survived the vote with the support of the DUP, allowing the PM to now seek an alternative deal to break through the parliamentary impasse.
Following the defeat of the Prime Minister’s Brexit deal, it is clear that the next few weeks will be an extremely turbulent time for UK markets. The EU is now unlikely to make significant concessions on the existing deal, and a lack of consensus within parliament on the way to proceed is likely to result in deeper divisions within the Tory party. Labour’s failure to force an election via yesterday’s vote of no confidence has increased pressure on the party’s leadership to back a specific Brexit plan. At this stage, the next steps for the government to move negotiations forward prior to the deadline are:
– Improve the current Brexit plan
Theresa May now has three days (as outlined in the Grieve amendment) to try to gauge what (if anything) would gain a consensus within the House of Commons and return with an alternative plan. As it stands, parliament is extremely divided, with no clear policy that will receive a cross party majority on Brexit. Some consensus must be ascertained before May can go back to Brussels for further negotiations, with the significant defeat of her deal indicating that no small tweaks would produce this consensus. The UK is currently in a weakened negotiating position with the EU, with the vote increasing the prospect of a softer Brexit and reigniting hopes for no Brexit, therefore Brussels is likely to keep pressure on the UK at this late stage of talks.
– Cross Party Communications
It is clear that given the divisions within the Conservative party, no parliamentary consensus will be gained without support from other parties, therefore the government is likely to take steps to facilitate cross-party communications in the coming days. Last night’s unsuccessful no confidence vote now means that Labour are likely to become more cooperative, and pressure is increasing on Jeremy Corbyn to back either a ‘softer’ Brexit or a second referendum as efforts to force a general election have been defeated. A cross party approach appears to be central to parliament finding a positive alternative to a no-deal Brexit within the remaining 10 weeks of negotiations, however the consensus must also be realistic to gain the approval of the EU. With deep divisions remaining between the Europhile and Brexiteer factions of the Conservative party, it remains unclear if a cross-party consensus will be possible to obtain, however efforts must be exhausted before moving to more radical moves such as a second referendum or extension of article 50. To break the parliamentary impasse, it appears that Theresa May will need to move some of her red lines to allow new approaches to be brought forward.
– Extension of Article 50
If the existing deal cannot be substantially improved and a cross-party consensus cannot be obtained, the next stage of negotiations would likely be to extend the Brexit deadline given in Article 50 to allow the UK more time to negotiate a deal. The EU has indicated that this would be permitted to secure a more substantial deal as it is now clear that unless the above short-term agreements can be made, a longer period would be required to consider a potential change in Conservative leadership or a second referendum. As it stands, time is running out, with just 71 days remaining before the deadline.
Does this bring us closer to a potential no deal scenario?
Although there is no clear consensus for getting a deal through parliament, the majority of MPs are unified in their desire to avoid a no deal situation at all costs. A no deal Brexit would have significant implications on the UK economy and sterling, with the Bank of England forecasting a 8% reduction in GDP, an unemployment rate of 7.5% and a 25% decline in the value of sterling in a no deal scenario. With no MPs wishing to be held as partly culpable for a no deal outcome, we see an extension and second referendum as being the most likely option prior to a no deal situation.
The alternative: A second referendum
If no deal can be agreed upon by both parliament and the EU, the UK electorate is likely to be given the choice between leaving the EU with no deal and remaining in the EU via a second referendum. Last night’s no confidence vote has increased the likelihood of a second referendum, with Labour policy leaving the door open to a referendum after a push for a general election has failed. As it stands, if a second referendum is held, a remain result appears most likely, leading to the revocation of Article 50. In the event that a second referendum is called, this would result in greater uncertainty, further division within the British electorate, and turmoil within UK markets over the near term.
Following the vote on the deal on Tuesday night, the FTSE opened unchanged on Wednesday, however following last night’s no confidence vote and some negative housing market data, markets were down 0.5% this morning. Sterling has been more volatile amid the continued Brexit uncertainty, dipping briefly before rebounding around 9am this morning. The outcome was expected and priced into markets, however it will be interesting to monitor market movements as the week goes on.
Our view on the most likely route forward
We view there as being no consensus to be had within parliament, with each party suggesting deals which are either impractical or would have very little chance of getting through the EU. We expect the Brexit chaos to continue over the next two months as the UK struggles to come up with a suitable deal, leading to the ultimate extension of article 50, followed by the resignation of Theresa May in favour of a new Prime Minister to spearhead renewed negotiations and compromise. In this case, we hope for a Norway style agreement which would keep Britain in the EU customs union and single market. If no deal can be made, we will have a second referendum which is likely to escalate tensions and uncertainty before a remain vote.
Implications to our positioning
As it stands, we currently have low levels of UK exposure within our OBI portfolios, with exposure coming from our multi-asset strategies and a FTSE 100 short position which seeks to benefit from a decline in UK equity markets. With the expectation of further chaos and market decline in the near term due to weaker economic data and continued uncertainty over Brexit negotiations, we view portfolios as being well positioned to benefit from a drop back in UK markets. When the future of the UK economy becomes clearer and UK equity valuations improve, high cash levels will allow us to take advantage of opportunities as they arise.
Key dates this week
– Thursday 17th Jan (today): May is holding a series of cross-party talks with senior parliamentarians
– Monday 21st Jan: Theresa May presents her plan B for Brexit to parliament
For anyone who wants further data to substantiate the position please review the attached Global Economic News Document.
Model Portfolios & Indices
Following the defensive repositioning of portfolios in December, our OBI portfolios have a low equity allocation, with exposure predominantly coming from the FTSE 100 and S&P 500 shorts as well as the Odey Long/Short European fund. For this reason, the equity exposure within portfolios is inversely correlated to markets ahead of the expected decline this quarter. As equity markets have in our opinion temporarily rallied over the week as a result of Chinese stimulus and what can only be put down to momentum trading, the portfolios have underperformed the benchmark, however the rally proved to be short lived, with most indices down today. If we look back to the decision on the 5th December to go defensive if we compare the portfolios if they had been left to the portfolio today then we are still marginally ahead with significantly lower volatility. Going forward we are starting to see the negative sentiment feed through and we would expect the decline in equities to commence and for the positioning to start showing benefits.
Our logic is based on the fact that key economic data continues to be increasingly negative, and indicative of weaker global growth, therefore we still expect a significant decline in equity valuations over the quarter. Over the coming weeks, we expect to see global trade concerns feeding into corporate earnings expectations, which should act as a catalyst to the decline in equity markets. In the meantime, amidst a high level of global uncertainty concerning US-China trade tensions, Brexit and US political developments, the portfolios benefit from a low level of risk, therefore investors can remain calm as turbulence continues in equity markets.
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the days movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested. Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1773, Captain James Cook became the first explorer to cross the Antarctic Circle.
As always have a wonderful week and stay safe.
Jason & Gina