The upward march of equity markets continued last week with global equities gaining another 1.2% in local currency terms. However, there was considerable divergence between markets. The UK resumed its recent strong run gaining 3.0% while emerging markets were down slightly on the week.
The UK’s gains occurred despite the Brexit talks going down to the wire and it still being far from clear whether we’ll end up with a Deal or No Deal. In a way, EU negotiations have almost always taken this form with deals only ever being reached at the eleventh hour. So, we should not really be surprised that after four years of negotiations, a deal is still hanging in the balance with little more than three weeks to go until departure day.
Very likely, we will know in the next couple of days whether there will be a Deal or not. As far as the markets are concerned, a Deal is clearly the preferred outcome. It would give a boost to both UK equities and the pound and favour domestically oriented small and mid-cap stocks over the FTSE 100. However, the impact is unlikely to be that great. After all, any deal will be a bare-bones one and is still likely to lead to short term disruption to the economy.
If there is No Deal, the reaction will be the reverse and the impact could be rather larger. Even so, it is unlikely to be that big for the simple reason that UK equities have underperformed substantially over the past few years, look particularly cheap and already price in a fair amount of bad news. The same seems true for the pound. It may be back up to $1.33 from a low of $1.16 in the spring but this is primarily due to weakness of the dollar rather than any great strength in the pound itself. Indeed, against the euro, sterling is still languishing at around €1.10 – only a little above its spring low of €1.06.
We have turned rather more optimistic on UK equities in recent weeks. This is because we believe the recent rotation out of this year’s winners, such as China and the tech sector, into the laggards, such as the UK and the banking and energy sectors, has further to run. This move should be driven by a strong global recovery next year on the back of vaccine roll-out and should not be de-railed by Brexit.
The UK is not the only country at a delicate point in negotiations over important economic matters. After months of wrangling, the US last week moved closer to agreeing a fiscal stimulus to replace the Covid-support measures which expired back in July. The pressure to reach an agreement has increased as the current surge in infections is leading to renewed restrictions which are putting the economic recovery under pressure.
Meanwhile, the EU on Thursday will try to secure agreement on its own €750bn economic recovery package. This had been signed off in principle last summer but is now in danger of being de-railed by Poland and Hungary. The same day should also see the European Central Bank announce a sizeable increase in its quantitative easing program but the truth is central banks everywhere are increasingly pushing on a string. Fiscal stimulus and vaccine roll-out, rather than further monetary easing, are the key to securing the strong economic recovery we now anticipate for next year.
Rupert Thompson
Chief Investment Officer