Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Companies most exposed to the UK are getting crushed
Christopher Dembik
Head of Macroeconomic Research
Summary: The path towards a Brexit resolution remains strikingly unclear, but one thing is certain: firms with high exposure to the UK market are taking it on the chin.
Despite the Kafkaesque political situation in the United Kingdom, the risk of an outright no-deal Brexit is quite low. The extension of the Article 50 deadline, for instance, could provide more time for the British government to find another solution. It could be a new referendum, or even an amended Brexit plan by Parliament. In other words, it is way too early to panic. Brexit is a very irrational decision, but it is unlikely that UK citizens and politicians are ready to commit political hara-kiri (or that European Union leaders would allow it).
There will be agreement, it is only a matter of time.
Limited macro impact but striking market impact
Brexit's macro impact is quite easy to evaluate: lower growth (though still above potential growth), higher inflation due to a lower GBP exchange rate and a lower savings rate as the British had to tap into their savings to cope with the economic slowdown.
On the other hand, assessing the impact of Brexit on companies is trickier. We can try to do so by using data from CBOE Bats (which covers 57 indices across 15 countries, pan-European and Eurozone regions, and Brexit and sector indices) as a benchmark for economic attractiveness and investment.
In the chart below, the blue line represents the 50 companies less exposed in terms of revenue to the UK market (Bats Brexit Low 50) and the red line represents the 50 companies that derive the largest portions of their revenues from the UK (Bats Brexit High 50).
The result is quite striking: Brexit UK risk premium is extremely high.
Since January 1, 2016, the performance of companies dependent on the UK market is negative (-4%) while that of companies least dependent on the UK market is nearly 40%! This gap is likely to remain wide if the Brexit political mess continues, and it can easily be explained by higher uncertainty regarding the UK’s relationship with the EU, negative consumer trends and the decline in the expected future openness of the UK to trade and investment.
All of this is making companies highly dependent on the UK less attractive for most investors, but for risk takers, the discount on stocks linked to Brexit constitutes a strong incentive to come back to this market.
There will be agreement, it is only a matter of time.
Limited macro impact but striking market impact
Brexit's macro impact is quite easy to evaluate: lower growth (though still above potential growth), higher inflation due to a lower GBP exchange rate and a lower savings rate as the British had to tap into their savings to cope with the economic slowdown.
On the other hand, assessing the impact of Brexit on companies is trickier. We can try to do so by using data from CBOE Bats (which covers 57 indices across 15 countries, pan-European and Eurozone regions, and Brexit and sector indices) as a benchmark for economic attractiveness and investment.
In the chart below, the blue line represents the 50 companies less exposed in terms of revenue to the UK market (Bats Brexit Low 50) and the red line represents the 50 companies that derive the largest portions of their revenues from the UK (Bats Brexit High 50).
The result is quite striking: Brexit UK risk premium is extremely high.
Since January 1, 2016, the performance of companies dependent on the UK market is negative (-4%) while that of companies least dependent on the UK market is nearly 40%! This gap is likely to remain wide if the Brexit political mess continues, and it can easily be explained by higher uncertainty regarding the UK’s relationship with the EU, negative consumer trends and the decline in the expected future openness of the UK to trade and investment.
All of this is making companies highly dependent on the UK less attractive for most investors, but for risk takers, the discount on stocks linked to Brexit constitutes a strong incentive to come back to this market.
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