Weekly market recap: disentanglement disagreements

Markets remain wary as parliamentary divisions threaten draft agreement.

FacebooktwitterlinkedinmailFacebooktwitterlinkedinmail   by Tertius Bonnin, 16th November 2018

Everyone’s attention was on the main event last week: back-stabbing, sparring factions grappling for power, and in-fighting amongst the ruling class. That’s right, HBO and Sky Atlantic have confirmed that the final season of Game of Thrones (GoT) will return in Q2 next year.

Only dragons were missing from the UK political scene, else last week could easily have been a scene taken straight from GoT itself! Asset class returns in sterling and local currency are below; the difference between sterling and local currency returns illustrates just how volatile last week was for UK investors.

Table 1: GBP total returns

Source: Bloomberg

Table 2: Local CCY total returns

Source: Bloomberg

There was extremely fast UK-related news flow last week which you will be forgiven for not keeping up with. Apologies in advance for the myriad of acronyms that are about to appear…

While markets – and indeed sterling – initially reacted well to UK Prime Minister Theresa May securing cabinet backing for her negotiated Withdrawal Agreement (WA), the situation quickly began to unravel following successive cabinet resignations and rising threats to the WA’s passage through Parliament from pro-leave and pro-remain MPs alike. This raises the question: why has the PM lost Parliamentary support over the “Northern Irish backstop” agreement?

We can categorise the PM’s waning support into three groups: the pro-leave European Research Group (ERG), the Scottish Conservatives, and Northern Ireland’s Democratic Unionist Party (DUP). The ERG’s malcontent arises from a clause within the WA which binds the UK into an indefinite customs union should trade talks (due to start in March 2019) break down.

Next, the Scottish Conservatives have taken issue to the backstop as it threatens to keep Northern Ireland in a closer regulatory relationship with the EU, thereby effectively creating a border in the Irish Sea. They see this as a provocation of Scottish Nationalists, who have continually campaigned to keep Scotland within the EU’s Single Market. Last we have the DUP, whose concerns are not dis-similar to those of the Scottish Conservatives. They famously said that their “blood red” lines in negotiations would prevent a border down the Irish Sea.

Chart 1: Parliamentary support for the PM’s Withdrawal Agreement will be hard-won and will likely require support from Opposition Benches

Source: EQ, Bloomberg

How is the WA likely to play out in Parliament? There are a huge number of variables now clouding the UK’s future relationship with the EU. Our decision tree which we would encourage you to have a look at attempts to set out in simple terms how we see this process going forward. With speculation that there could be further cabinet resignations and letters supposedly flooding into the inbox of the Conservative Party’s backbench committee chairman, the probabilities of each path are constantly shifting.

In recent months, sterling has become a barometer for investor sentiment regarding the UK’s pending withdrawal; it dips when it becomes more likely that the future relationship will be governed by World Trade Organisation rules and rises with the likelihood of an eventual deal. However, last week the markets had trouble second-guessing the UK future path. Shifting speculation is highlighted by the circle on the chart below where a press conference held by at Downing Street was announced, cancelled, and then subsequently re-announced, sparking fears that the PM was struggling to convince her Cabinet colleagues.

Chart 2: The pound, against both the dollar and the euro, had a volatile week as news flow whipsawed investor sentiment

Source: Bloomberg

Investors, journalists and politicians alike will be counting the number of letters calling for Theresa May’s resignation as the risk of a Conservative leadership challenge looms. Beyond this, an emergency EU Council meeting has been called for the 25 November where the deal will be formally agreed; this will then mark the start of Parliamentary proceedings. Any major development will be reflected in both UK equities and sterling which are likely to remain volatile while we face heightened political uncertainty.

THE WEEK AHEAD

Monday: N/A

Tuesday: France Unemployment Rate

Wednesday: US Durable Goods Orders, US Existing Home Sales, Japan Inflation Rate, European Central Bank Non-Monetary Policy Meeting

Thursday: Eurozone Consumer Confidence

Friday: Germany Markit Manufacturing PMI, Canada Inflation Rate

Saturday: N/A

Sunday: Emergency EU Council Meeting

STAT OF THE WEEK: 1 in 3 – the proportion of babies born today who will live to the age of 100 (MoneyWeek).

Data correct as at: 16/11/2018

About the author: Tertius Bonnin

Tertius joined EQ in 2016 and is responsible for covering investment ideas within US, Global and Thematic equities. He sits on the fund selection committee and also supports the portfolio managers across a range of other responsibilities.

He passed Level I of the CFA exam in 2018, holds the Investment Management Certificate and has a BA in Business with Finance. He enjoys a variety of sports including skiing, cycling and running – and when not in the office he experiments with Asian cuisine.

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