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The Christmas present no-one wants

Tom Stevenson

Tom Stevenson - Investment Director

It’s decision time in Brussels and London, where the EU and both Boris Johnson and Jeremy Corbyn have some tough calls to make in the next few days.

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While these are principally political decisions, Brexit is the main driver of market sentiment here in the UK and is a key influence on financial markets, via the currency in particular. Investors may prefer to shut it out of their minds, but for the next few months at least they unfortunately do need to pay attention.

The first decision is for the EU. Brussels must decide whether to grant an extension to the stalled Brexit process, and for how long. With the UK Prime Minister having delivered a legally-required but grudging request for delay last Saturday, the EU has three options: agree to extend the process until the end of January, offer a shorter delay or (unlikely) refuse to grant an extension.

The current thinking is that Brussels will meet the UK’s request and go for a ‘flextension’ which names January 31st as the new deadline for leaving the EU but allows for an earlier departure if the legislation is in place.

This is the politically neutral option because it avoids being seen to have taken sides. Offering a long extension, however, does point towards an election on the basis of the Prime Minister’s initial reaction to his latest defeat in Parliament on Tuesday. He said then that a long delay would force him to abandon the Withdrawal Agreement Bill and, presumably, go to the country.

That leads to the second key decision. Boris Johnson must decide whether to go for an election now or to try one more time to get his Brexit deal approved by Parliament. The Cabinet is apparently split on which is the right approach.

The case for an early election for the Conservatives is that now is the moment of maximum leverage for the ‘People vs Parliament’ platform that some advisers, including Number 10 adviser Dominic Cummings, advocate.

The danger of going before Brexit is achieved is that the Brexit Party remains in play and may split the Leave vote to the Conservatives’ disadvantage.

Decision number three is for the leader of the Labour Party. Mr Corbyn must decide whether to agree to an election in which Labour is currently well behind in the polls. Labour would much rather be tackling the Government on other domestic issues where it is on stronger ground than Brexit, where it is clearly split down the middle.

But given that the Government has no majority and can’t struggle on for another three years until the next scheduled election, a vote will happen at some point soon. Key voices in the Labour movement are concluding that they just need to get on with it.

So an election before Christmas is possible, albeit the timetable is pretty tight and a decision must be made within a few days if it is to be squeezed in before the holiday. A December election is extremely unusual - generally Governments avoid going to the polls in the dark winter months, especially when people have their mind on a different sort of party.

What does all this mean for investors? In the short-term markets have responded favourably to the fact that a no-deal exit does seem to have been taken off the table for the time being. There is now little danger of Britain crashing out on 31st October. A hard Brexit at the end of the transition period (end 2020) is still conceivable but in political and market terms that is a lifetime away.

Sterling has risen to close to $1.30 and many observers think that a move higher to $1.35 or even the long-term pre-referendum floor of $1.40 is now possible.

This would not be particularly good news for the FTSE 100, which has kept its head above water in the past three years largely because of the benefit to exporters and overseas earners of weak sterling. A stronger pound would be much better for the domestic stocks in the FTSE 250 and would also argue for a shift back to economically-sensitive value stocks than the defensive international businesses that have prospered in the past three years.

These smaller shares would also benefit from greater clarity on the outlook. Businesses might start to invest again and consumers would be more relaxed about making financial commitments too.

So, investors need to be selective. But there is a growing sense that a resolution of the long-running Brexit uncertainty could focus minds on the generally appealing valuations of the UK market, where shares are currently trading on around 12 times expected earnings, towards the bottom end of the long-term range. With earnings expected to grow at around 7% and the average dividend yield close to 4%, the very real concerns in the UK market do seem pretty well priced-in at the moment.

The Select 50 has a broad range of UK-focused funds including a couple that are weighted towards the value stocks that should do well in a recovering environment.

The Fidelity Special Situations Fund, managed by Alex Wright, is a classic contrarian fund that looks for out of favour stocks where there is a catalyst for improvement.

The JOHCM UK Equity Income Fund, as its name suggests, looks for shares which offer a higher dividend than the market average. It has a value focus but will only invest in companies where there is a good prospect of earnings and the dividend growing over time.

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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