Emerging from Both COVID and the EU Is a Rather Good Prospect…

Melbourne, Australia
Saturday, 20 March 2021
Twitter: @DRAUS

[6 min read]

Dear Reader,

I favoured Brexit, but only mildly and with trepidation. You see; Brexit itself merely changes who governs Britain, not what laws they actually make. Able to shape Britain’s destiny for themselves, instead of delegating to the EU. Who really knows what the Poms (like me) would come up with?

My expectation was for a very gradual divergence from the EU. One that would take a very long time to occur, and it would take even longer for the costs and benefits to emerge. Long enough that nobody would ever be able to attribute neither the costs nor the benefits to Brexit, because so many other things will have happened by then: COVID case in point.

But it appears I was wrong. The Brexit boom is on. And the Brexit Britain breakaway from its peers is beginning. I think it’s time to stake your claim on one of the most intriguing investment stories out there in the world today.

What is that story?

Well, much of the world still thinks Brexit is mad. But that’s rapidly shifting. And financial markets will eventually price in the upside risk. The risk of a pleasant surprise. A Brexit boom instead of doom.

Let’s review what has me so interested in the investment premise of Brexit Britain, before telling you how to stake your claim. And how not to.

Let’s start with the obvious piece of evidence — vaccines and COVID.

Cases are rising in much of Europe. Italy is back in lockdown. France will be soon.

Meanwhile, Britain’s vaccine rates are surging ahead. And the Europeans are doing their damnedest to fall further behind. It’s unclear whether they want EU citizens to laugh or cry, but as long as they can’t vote in or out the European Commission, why worry about what the electorate thinks?

If Europe gets another wave of COVID and Britain does not, their economies would diverge dramatically. This one sequence of events could, quite frankly, define both Brexit and Britain for a very long time. Rightly or wrongly, fairly or unfairly.

COVID may be the poster child of why Brexit was a good idea, and it may be a good reason to invest in Britain today — the first major financial market to escape the pandemic. (Hopefully.)

But vaccines are not the only reason.

There’s also interest rates. Going into the pandemic, the UK bucked the trend in Europe by having any interest at all. While the ECB, Swiss central bank, Swedish central bank and others kept rates at zero or below, the Bank of England stayed positive.

And now UK interest rates are diverging again, but in a different way. Financial news site Bloomberg summed it up like this:

‘While the ECB reads higher yields as a threat to the euro zone’s already-delayed recovery, BOE Governor Andrew Bailey on Monday joined his colleagues in viewing it as a sign of optimism that the economy is about to rebound from its worst recession in three centuries.’

The same news, but with opposing conclusions? Rising rates are bad for the eurozone and good for the UK? How can that be? It’s the sort of obfuscation you’d expect Brexit critics to come up with. But note it’s reversed…

Well, interest rates can rise for differing reasons and they can have differing effects when they do rise.

Over-indebted governments, companies and people can experience financial difficulty when interest rates rise. And interest rates can rise as lenders get cold feet, withdrawing their support.

Or rates can rise because of optimism about the economy, when investors and lenders require better returns for their money because riskier investments are performing well.

If Europe is in for an interest rate driven debt crisis, while the UK begins to grow and provide better interest rate returns to investors, this would be an extraordinary divergence.

Of course, eventually a European debt and economic crisis becomes a UK one thanks to economic ties. But that would only add to the Brexit narrative by justifying even more the attempt to distance Britain as much as possible from the EU by opening trade ties elsewhere. Remember, the EU is a trade bloc that favours free trade internally, but locks out other nations.

The UK’s higher rates are also attracting more and more investors…ironically, some of the ones who were very harsh about the EU referendum result. The Financial Times reports ‘Japanese investors buy UK government bonds at record rate in early 2021’.

Another record despite Brexit. Why?

‘Reduction in risk from Brexit and negative rates have boosted appeal of British debt’. They no longer fear the pound falling as much. I think Aussie investors shouldn’t either. They should be seeking to profit from a rising pound.

On GDP itself, Bloomberg added:

‘Britain’s outlook is diverging from the rest of Europe’s. A slow pace of vaccinations has held back the euro zone’s economy and threatened to extend lockdowns. Output is expected to contract again this quarter and not return to its pre-pandemic size until well into next year.

‘By contrast, the U.K. has enjoyed a string of good news on the economic front. While output is set to contract in the first quarter, the BOE expects a rapid rebound to pre-Covid levels over the rest of 2021.’

On the one hand, it will be disappointing if COVID overshadows what would’ve been good economic results after Brexit. It’s been fun watching what Brexiteers dub ‘Project Fear’ get exposed as clueless savants. On the other hand, the vaccine stoush demonstrates why Brexit is a good idea rather nicely. Just don’t expect Project Fear to agree on that. The undecided middle of the UK might though.

As would global CEOs and firms, apparently. The consulting firm Accenture recently reported on the results of its regular survey, as reported on by Reuters:

‘The global poll of 12,000 manufacturers and services providers, conducted three times a year for consultants Accenture by data company IHS Markit, showed 68% of British firms expected activity to rise, while 11% saw a fall.

‘The net balance of +57% is the highest since June 2015 and up from +34% in October, and also tops readings for businesses in the United States, Japan and continental Europe.’

The accounting firm PwC chimed in with this:

‘Britain is a more attractive investment proposition for multinational companies than it was before Brexit, a survey of 5,000 global business leaders has found.

‘The UK has overtaken India as the world’s fourth most promising growth opportunity, according to PwC’s annual CEO Survey.’

The car industry led warnings of Brexit doom before the referendum and before the trade deal with the EU. But since then, it has become a supporter of Brexit as trade deals with nations outside the EU are boosting UK car manufacturing.

Ford hailed the deal with Turkey while confirming production of its Transit Vans. Reuters reported this: ‘Nissan will source more batteries from Britain to avoid tariffs on electric cars after the UK’s trade deal with the EU, which a senior executive told Reuters turned Brexit from a risk into an opportunity for its factory in northeast England.’ And so on and so forth.

Now, none of this optimism is truly in the bag. In fact, I’m very worried about a fourth wave in the UK and what this would do to the global outlook. The virus has done an excellent job of humiliating all politicians so far, so it’d be naïve to assume there isn’t another twist left.

But financial pundits love to talk about something called ‘upside risk’. It sounds like an oxymoron — how can risk have upside? The idea is that we get surprisingly good news.

As the last few weeks have shown, surprisingly good news is bad for investors who hold investments that benefit from bad news, such as government bonds. And so there is risk from upside surprises for investors.

It’s also important to keep in mind that I’m focusing on relative terms. The UK’s news is a lot better than the EU and eurozone’s. Investing is a game of alternatives. Where should you put your money to work? I think the UK should be top of your list right now. And Europe a lot lower. Which is a reversal of the advice you’re likely to find elsewhere.

But ‘UK’ doesn’t exactly narrow it down very much…where do you actually invest?

Well, first things first. Buying the UK’s broad stockmarket index is a bad idea. Passive investing in the FTSE 100 won’t work if you want to profit from a Brexit boom, for a simple reason, the FTSE 100 isn’t very British at all. It’s full of global companies with global revenues.

76% of revenues for FTSE 100 companies came from outside Britain in 2017. For the mid-cap FTSE 250, it was around 50%. So even that won’t work.

You’ll have to be picky about what you invest in. And do some digging.

What we want, to profit from Brexit, is companies with revenues in the UK. If you believe in Brexit, you likely expect the pound to surge. This means importers are a good idea too. Preferably from outside the EU…

Where does that leave us?

Well, when I put together a Brexit Boom Portfolio for my UK subscribers in 2019, I created a long list. But here are my two favourites:

Ocado Group PLC [LON:OCDO] is a leader in online grocery shopping and delivery. It provides the software systems that make it all work. The company is increasingly expanding overseas. In fact, our local grocery shop in small-town Japan uses their software…but it’s still booming in the UK.

Dunelm Group PLC [LON:DNLM] imports furniture and furnishings, and sells them in the UK. It is the country’s top homeware retailer.

Of course, these are not recommendations. But they illustrate the sorts of characteristics I’d look for when trying to profit from Brexit. And the time is now.

Until next time,

Nickolai Hubble,
Editor, The Daily Reckoning Australia Weekend