Investors have got this far without believing the Brexit bluster.
The government has said for months, even years, that it is prepared to drop out of the EU single market and customs union without a deal, but fund managers have opted to write this off as posturing for a domestic audience and for Conservative party internal politics.
Now, with less than a month to go, they are not quite so sure.
Reports of a lack of progress in talks are hardly new. They crop up with Groundhog Day-like regularity. The difference now, as both the EU and UK sides indicate talks may not succeed in forging a framework for a future relationship, is that only just over three weeks remain before the UK drops out without a safety net.
Monday's resulting fall in sterling — its biggest since September — is a sign that this was not, in market parlance, “priced in”. The consensus has always been that cool heads will prevail in the interests of economic stability, particularly on the back of the biggest economic decline in more than 300 years — a slump the country is struggling to reverse.
That consensus is visible in recent market patterns. UK stocks have been unusually slow to recover from the coronavirus shock of March — they are still 13 per cent weaker on the year so far, while US markets have demolished record highs and some markets in Europe have clawed closer to the flat line. But November brought the FTSE 100's best performance since 1989, piggybacking on the worldwide rally in stocks previously beaten up by the pandemic.
Similarly, sterling last week hit its highest point of the year, buoyed by the declining dollar, with data from the US futures market showing that negative bets on the pound have been falling away fast. This all gives the currency a long way to fall if the talks fail and leave investors wrongfooted.
The stakes are high, just as global markets enter the flighty liquidity conditions of the Christmas period that could easily exacerbate any shifts, as the wobble in global markets at the end of 2018 showed. And the likely outcomes for UK markets from here are lopsided. Declines in the event that the talks fail could be ugly, while potential for rallies on a last-minute breakthrough is likely to be more limited.
“There's no question that the UK is deep value and could initially rally if we get a nice deal,” says Maya Bhandari, a multi-asset portfolio manager at Columbia Threadneedle Investments. “We could see a short-term bounce, but I don't expect it to be long lasting.”
In part, that is because any deal struck now would be rather thin gruel. Commercial life from January will still look very different to how it did before, with bundles of red tape, delays and confusion. “Whatever deal we see now would have been viewed 12 to 18 months ago as a catastrophic cliff edge,” says James Athey, an investment manager at Aberdeen Standard Investments. “Everybody's expectations have shifted.”
A deal would also fail to address some of UK markets' longstanding issues.
“To be honest we find it quite difficult to get excited about UK markets, and we are neutral on sterling,” says Ms Bhandari. “We have been asking ourselves: UK stocks are cheap, but are they cheap for a reason?” Ms Bhandari has instead picked up value stocks in Japan and elsewhere in Asia.
The UK markets' heavy tilt towards “old economy” stocks in energy, financials and materials is just not terribly appealing to some fund managers, Brexit trade deal or no.
Investors are not at panic stations yet. Far from it. The latest shake-up in sterling is nowhere close to the scale of referendum night of 2016. “I do believe we get a deal because both sides will recognise that they are better off, economically speaking, with one. Therefore we are buying sterling today,” says Gregory Perdon, co-chief investment officer at private bank Arbuthnot Latham.
UK stocks have a lot to offer to bargain hunters. Large tech stocks — not an area where the UK excels — have recently fallen out of favour, or at least are now rising at a slower pace. Instead, those unsexy old economy sectors are back in demand. Investors are betting that the companies hardest hit by the coronavirus outbreak will be the biggest beneficiaries of the vaccines that are on the brink of hitting the world's bloodstream.
Some of that potential can still be tapped. “I sincerely believe that if there's an agreement, that would take away one of the things that has been holding people back from buying UK assets — the risk from sterling,” Mr Perdon says.
But the time for proving the optimists right is running out.
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