Today in Brexit, Day 1,644

Editors’ Note: As always, our political commentary is intentionally non-partisan. We do not advocate for or against the UK leaving the EU and assess developments like these exclusively for their potential market impact.

Well how about that! In perhaps the least 2020 thing to happen all year, UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen agreed overnight on a post-Brexit trade deal. It reportedly took 24 hours of telephone haggling over fishing rights, which ended in an agreement whereby EU fishing boats can access UK waters for five-and-a-half years but the value of their catch must fall by 25%—a deal we are sure some on both sides will find delectable and others will find, well, fishy.^[i] Oh, and trade between the UK and EU will remain tariff free and not subject to caps or other restrictions, a win for businesses on both sides. Now, we have long argued a deal isn’t necessary for both sides’ economies (or stock markets) to do fine once the post-Brexit transition period ends next week, so we don’t view this as some whopping positive or super-bullish catalyst for stocks. But it zaps most remaining Brexit-related uncertainty, giving businesses clarity on trade costs from here on out. More broadly, it probably helps boost sentiment, which adds to the blooming animal spirits as 2021 dawns.

Beyond the fishing bargain, the agreement offers little that wasn’t already expected. It puts the UK outside the EU’s customs union, giving it noteworthy freedom to diverge from EU regulatory standards—a key point for those who were pro-Brexit. As a result, there will be border checks on goods crossing the Channel and/or Irish Sea (the border between Ireland and Northern Ireland remains unfettered, consistent with 1998’s Good Friday Agreement that brought peace to the island). Those checks could cause some near-term backups and delays as freight firms adapt to new paperwork and procedures—not dissimilar from the interruption France closing its borders tied to COVID response caused in recent days. Moreover, the deal doesn’t apply to services—including financial services, meaning UK-based firms need to have a physical EU presence to ensure market access. That said, this was widely expected and led many firms (including our own) to establish footholds in EU jurisdictions to serve customers there over the past few years. It also remains possible that London-based banks gain access later if the sides reach an agreement on regulatory “equivalency” or thereabouts.

We should note, there is still room for this deal to flounder.^[ii] Fishing rights are a very sensitive issue for both sides, which may make it difficult for von der Leyen to sell the deal to all 27 EU member-states—and for Johnson to secure Parliamentary ratification. However, we would be surprised if the opposition amounted to more than symbolic grandstanding, especially on the UK’s side. It seems just a bit of a stretch to imagine a few dozen members of Johnson’s Conservative Party banding against their leader to deliver their constituents a no-deal Brexit for New Year’s. That would be a very questionable political move, to put it mildly. Similar calculations apply at the EU level, given the UK is a key export market for several EU nations. Politicians have a funny way of bending at the last minute to avoid disadvantaging their own constituents, lest they hurt their re-election chances.

So presuming the deal passes and goods trade across the English Channel remains free, no-deal Brexit uncertainty just vanished, removing one long-running headwind from UK stocks. The UK is the MSCI World Index’s worst-performing constituent country year to date, down -12.9% in USD versus the world’s 13.8% rise.^[iii] In our view, a lot of lag stems from the UK’s heavy value tilt and minimal Tech exposure. But the UK is also lagging world value stocks, which we think is a decent indication of Brexit’s overhang on sentiment. With this cloud now lifting, the UK probably stands a much higher likelihood of performing more or less like global value, even if it keeps trailing the world overall.

Getting a Brexit trade deal probably also helps sentiment globally, as no-deal dread wasn’t solely a British or European phenomenon. It featured regularly in US headlines as well. Now investors in Europe and America have one less thing to fear, which adds to the general sense of cheer we are noticing among investors as 2020 ends. It wouldn’t shock us if warming sentiment were one of next year’s big themes.

In the meantime, we should reiterate, nothing that happened this week strikes us as make or break for markets. Tariff-free trade is a small economic positive, sure, but the small tariffs that would have taken effect in a no-deal scenario almost certainly wouldn’t have derailed trade overall. Businesses are very good at absorbing these small costs, as the US and China have proven over the last two-and-a-half years. In all likelihood, as investors saw life go on mostly as usual post-Brexit, especially after being forced to deal early with chaos at the ports, uncertainty would have fallen and boosted markets. The only thing different now is that instead of this being a gradual, almost subconscious realization, investors get the good news all at once. Maybe it pulls returns forward a bit, but we doubt it has much effect beyond that.

Still, good news is good news, especially at the end of a year like this. So keep an eye out for any last-minute snafus, but in the meantime, feel free to crack a smile or three.