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Key points

  • Although Brexit uncertainty has had little impact on the U.S., it continues to weigh on the U.K. economy and shows no signs of abating in the run up to October 31st, the date set for the United Kingdom’s official withdrawal from the European Union. Against this backdrop, we consider how investors can best position their portfolios.
  • U.K. GDP registered its first quarterly contraction in seven years in the second quarter of 2019, while manufacturing PMI data point to an ongoing contraction, with August’s results showing the steepest monthly contraction since July 2012.
  • Investors shied away from U.K. assets in the run up to Boris Johnson’s appointment as Prime Minister in July until mid-August, but flows were slightly positive in September-to-date.

Although the uncertainty surrounding the U.K.’s departure from the European Union has had little impact on the U.S. to date, in the U.K. growth is slowing. GDP contracted -0.2% in the second quarter of this year – the first quarterly drop in seven years.1

Furthermore, economic indicators are showing a sustained contraction in the manufacturing sector, and the UK’s dominant services sector is stagnating. Our in-house GPS growth indicator points to room for downside surprise for U.K. growth, given muted business investment and a global industrial sector contraction.

Bright spots do remain, however: Wage growth, up 4% in the three months ending in July, has been trending up since mid-2017, while unemployment was 3.8% for the May to July period, the lowest level since the 1970s (Source: Office of National Statistics, September 2019).

Brexit uncertainty has largely played out through sterling, which has proved to be increasingly volatile, ranging from +5% to -6% at YTD highs and lows.2

Sentiment towards UK and European assets

With the UK’s departure currently scheduled for October 31st, and the increasing volatility around an economically disruptive “no-deal” Brexit, investors shied away from U.K. assets in the run-up to and post Boris Johnson’s appointment as Prime Minister since May. More broadly, exchange traded products (ETPs) that focus on broad European exposures have seen outflows year-to-date, given the uncertainty around such events as Brexit and geopolitical risk in Italy.

Euro-wary investors

Euro-wary investors

Source: Markit, Blackrock, as of 9/20/19.

Investors have preferred U.K. fixed income exposures this year, with around $500 million added to globally listed U.K. fixed income ETPs in each quarter of 2019. In contrast, U.K. equity buying was largely concentrated in the first quarter, before the initial March 29 Brexit deadline; the $1.9 billion added over this period was the largest quarterly inflow into U.K. equity ETPs. Since then, subsequent quarters have registered outflows of $252 million and $116 million respectively (Source: BlackRock, Markit, as of September 20, 2019).

Although Brexit has had little impact on the U.S. economy or markets to date, uncertainty around the event remains a risk. Against that backdrop, we set out four scenarios below that are still viable outcomes for Brexit, and have aligned them to be either triggering an upside reaction or downside reaction in assets. These scenarios are not mutually exclusive.

  1. A further extension of Article 50, also known as the clause that outlines the steps for leaving the EU, (potential upside as it is an extension of the status quo)
  2. A form of the Withdrawal Agreement passes in Parliament (potential upside as it is an orderly exit)
  3. No-deal exit (potential downside as the outlook is extremely uncertain)
  4. General election (potential downside as this creates more uncertainty)
Upside (Scenarios 1, 2)Downside (Scenarios 3, 4)
Potential implementation for U.S. investors U.K. equities Long duration U.S. Treasuries
  Broad developed market equities Gold and diversified commodities
  Eurozone equities Minimum volatility strategies
Christopher Dhanraj
Head of iShares Investment Strategy
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