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What Brexit Outcomes Could Mean for Investors

Negotiations for the UK’s exit from the EU are reaching a boiling point

Syl Flood 

 

The United Kingdom has been negotiating its exit from the European Union since the Brexit referendum in June 2016. The situation is highly dynamic politically. For investors outside of the U.K., the situation may be difficult to follow, so our goal is to provide some clarity around the risks and opportunities for investors.

5 scenarios for the outcome of ongoing Brexit negotiations

  1. A "soft" Brexit: This is a deal that would leave the U.K. in a close relationship with the European Union. From an economic and investing perspective, this is the best-case scenario. From a political perspective, this path is viewed by those who voted to leave the union as a betrayal.
  2. A deal that results in a less close relationship between the U.K. and the EU.
  3. A no-deal Brexit with disruptive outcomes.
  4. A no-deal, disorderly Brexit: This is the worst-case scenario from an economic and investing perspective.
  5. A second referendum resulting in a remain vote.

In this post, we’ll discuss the prospects of the last two scenarios.

What a no-deal, disorderly Brexit outcome could mean for investors

Given what we currently know, Morningstar assigns a 30% probability to scenario #4: a worst-case, no-deal, disorderly Brexit. Such a no-deal would result in a negative economic shock to the U.K. economy: a downturn in economic growth, inflation, an increase in the unemployment rate, and sterling devaluation. But crises raise both risks and opportunities.

Our equity research team assessed threats and opportunities relative to the disorderly exit scenario. We see opportunity in selected, attractively valued sectors of the U.K. equities market. For example, we see consumer stocks with a strong competitive advantage as most immune to a worst-case-scenario Brexit.

Is a second referendum feasible?

A second referendum may seem logically or emotionally appealing, but it may not be logistically feasible. For one, it requires an Act of Parliament with the backing of the majority of members of Parliament—a cross-party initiative which could result in further resignations leaving both main political parties weakened. We explain more about the feasability of this outcome in our Brexit brief.

UK investors have stayed the course since 2016

Despite headlines suggesting otherwise, U.K. investors have not fled en masse from U.K. equity funds. From June 1, 2016, to the end of October 2018, U.K. equities experienced EUR 16.7 billion in net outflows. That sounds like a lot of money. It isn’t. The category had EUR 528 billion at the beginning of the period. Overall, U.K. investors have contributed a net EUR 177.5 billion into long-term funds over this period. This lends further credence to the hypothesis that investors have stayed put.

Brexit is difficult to analyze because of the indirect and tenuous connections it has on investment fundamentals. Therefore, we encourage investors to stay focused on long-term, fundamentally sound investment analysis.

Read Morningstar’s latest report that compiles our key insights and analysis on Brexit.

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