Nearly two years ago, the UK’s vote to leave the EU shook sentiment globally. In our coverage of UK media, we found many economists forecasting that Brexit would have major implications, including some claiming the vote would stoke uncertainty and harm Britain’s economy. We saw economists single out business investment, commercial property and finance jobs as being at high risk. But today, data measuring these allegedly at-risk areas suggests most of these worries may have been overblown. In our view, the persistent fears against a brighter reality suggest sentiment is too dour and underlying economic strength underappreciated, which creates an environment where equities often thrive.
It seems fair to say that the UK’s economic resilience would have surprised those foreseeing doom and gloom after the vote. Back then, we saw many analysts warn that uncertainty would dry up business investment and hinder economic growth. The IMF cut its 2017 growth estimate for UK GDP by 0.9 percentage point after the vote, fearing weak investment and a mass exodus of financial firms (and their jobs) would weigh on growth. Analysts suggested ‘tens of thousands’ of jobs would leave the UK. Green Street Advisors, analysts specialising in real estate, estimated about 40,000 financial-sector jobs would leave.[i] Many investors fled property funds, believing the exodus would drive commercial property vacancies up and values down. Some speculated commercial property values could drop as much as 20 per cent.
However, while pundits feared the vote would discourage investment in the UK, merger and acquisition (M&A) activity and rising business investment tell a different story. The value of M&A activity in Q1 2018 surged to levels not seen in 11 years, according to Thomson Reuters. Some say the rise stemmed from domestic firms building scale to cope better with conditions in a post-Brexit world. While that may be the case in some instances, we believe it doesn’t explain the rise in foreign firms’ acquisitions of UK companies, which more than quadrupled in value from Q1 2017. Sure, big deals skew value data. However, there were 63 deals involving foreign firms acquiring UK firms in 2017 versus an average of 41 from 2012 through 2016, according to ONS data. Besides, if companies launch huge mergers, that seemingly doesn’t speak to a lack of confidence in the post-Brexit outlook. Note also that with sterling higher in Q1, this doesn’t appear to be a case of foreign firms going bargain-hunting in Britain, which some observers argued fuelled the rash of foreign acquisitions in the months after the referendum, including SoftBank’s purchase of ARM. Overall, we believe M&A activity doesn’t suggest international investors fear the post-Brexit environment.
As for business investment since the vote, at first blush it might not look strong. As Exhibit 1 shows, although quarterly growth was less choppy after the vote than before, business investment has not grown at a torrid pace. Pre-referendum uncertainty appeared to cool investment during the year before the vote, and the recovery after the vote, though positive, was slow.
Exhibit 1: Business Investment Before and After the Brexit Vote
Source: Office for National Statistics, as of 10/4/2018. Quarter-over-quarter growth rate and level of real UK business investment, Q4 2012 – Q4 2017. Dotted line indicates Brexit referendum.
Yet while many observers have characterised this as a sign of weakness, we believe looking at business investment’s categorical breakdown tells a different story. Exhibit 2 shows quarterly growth rates for each of the four main categories over the same period. The two weak categories since the referendum, Transport Equipment and Other Machinery & Equipment, have strong ties to the energy sector, where low oil prices have discouraged investment since before the referendum. Categories less tied to energy, like Intangible Fixed Assets — which includes software and research & development — have strengthened since the vote.
Exhibit 2: UK Business Investment by Category
Source: Office for National Statistics, as of 20/4/2018. Quarterly growth rate of real business investment in transport equipment, intangible fixed assets, other buildings & structures and other machinery & equipment, Q4 2012 – Q4 2017. Y-axis cuts off at -15% and 15 per cent in order to prevent outlying results in transport equipment from obscuring results in other categories. Dotted line indicates Brexit referendum.
Data also suggests that fears of crashing property markets were likely overstated. Commercial property transaction values in the UK rose 20.6 per cent y/y in 2017, according to data from Real Capital Analytics.[ii] Skyscrapers such as the ‘Walkie Talkie’ and the ‘Cheesegrater’ both sold for more than £1billion, record prices, as international capital poured in. It’s not the sort of activity you would expect if doomsday scenarios were playing out.[iii]
More recent data suggests property markets remain healthy. As of 31 March, the central London vacancy rate was 5.97 per cent, well below post 2008-highs and below the ten-year average of 7.04 per cent, according to BNP Paribas Real Estate.[iv] Solid demand from tech and media firms has helped strengthen the market Since the UK remains in the EU pending the Brexit process’s conclusion, and will retain most membership benefits through the transition period ending on 31 December 2020, one might argue that the pain is merely delayed, and vacancies will start soaring once Brexit is complete. While some firms might decide to relocate European staff, new property lease lengths remained high after the referendum. According to MSCI, new property lease lengths averaged 7.1 years in 2017, down just slightly from 7.2 years in 2016. If firms had plans to vacate the country before Brexit took effect, we believe they likely would not be signing such long-term leases.
Similarly, job-related fears about the financial sector haven’t played out. Recent estimates suggest far fewer finance jobs will leave the country than analysts initially expected. Green Street Advisors estimates 20,000 to 25,000 finance jobs will eventually go, with only 5,000 departing by March 2019, when Brexit is scheduled to become official.[vi] Deutsche Bank once estimated it would move 4,000 jobs, but now expects only 200 to leave.[vii] Goldman Sachs lowered its estimate from 1,000 to 500.[viii] While 25,000 might sound large, consider that as of December 2017, more than 1.1 million people worked in UK financial services, Green Street’s estimated departures represent just 2.2 per cent of the industry’s current workforce.[ix]
Additionally, we see no evidence that the exodus has started. Between June 2016 and December 2017, total employment in this industry rose by 12,000 workers, a 1.1 per cent increase.[x] Here, too, if firms were broadly planning to cut UK headcount, we believe they probably wouldn’t be adding workers now.
But despite fears not playing out and fundamentals apparently remaining resilient, ongoing media coverage suggests many remain dour, which we believe presents opportunity. For example, a CBRE survey of 100 multinationals that occupy space in the UK showed 39 per cent still believe that Brexit will have a ‘negative impact’ as of late 2017. Many economists also hold gloomy growth projections for the UK economy.[xi] The IMF believes that over the next two years UK growth will underperform all of Europe, except Italy.[xii] We believe surprises move markets most, and in our view, an economy with a large positive gap between expectations and reality carries high positive surprise potential. To us, persistent Brexit doom fears, coupled with the brighter-than-appreciated reality, are a bullish backdrop for British shares. We believe data from business investment to banks’ transfer plans echoes this point.
Investing in equity markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world equity markets and international currency exchange rates.
This document constitutes the general views of Fisher Investments and should not be regarded as personalised investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts may be, as accurate as any contained herein.
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[i] Source: “So Far So Good: Financial Firms Commit to London Despite Brexit Concerns,” Olga Cotaga, The Wall Street Journal, 3/4/2018. https://www.wsj.com/articles/so-far-so-good-financial-firms-commit-to-london-despite-brexit-concerns-1522753201
[iii] Source: “London’s Commercial Property Market Defies Doomsayers,” Judith Evans, Financial Times, 19/9/2017. https://www.ft.com/content/bcd274e6-6dff-11e7-b9c7-15af748b60d0
[iv] Source: “So Far So Good: Financial Firms Commit to London Despite Brexit Concerns,” Olga Cotaga, The Wall Street Journal, 3/4/2018. https://www.wsj.com/articles/so-far-so-good-financial-firms-commit-to-london-despite-brexit-concerns-1522753201
[ix] Source: ONS, as of 20/4/2018. Workforce jobs by industry, financial & insurance activities, December 2017.
[x] Ibid. Workforce jobs by industry, financial & insurance activities, June 2016 – December 2017.
[xi] Source: “Gloomy Growth Projections Cloud Hopes for UK Economy,” Gavin Jackson and Gemma Tetlow, Financial Times, 1/1/2018. https://www.ft.com/content/ceb165ee-ebb5-11e7-bd17-521324c81e23
[xii] Source: “UK Economy to Underperform All of Europe Except Italy—IMF,” Chris Giles, Financial Times, 17/4/2018. https://www.ft.com/content/677249ca-4236-11e8-803a-295c97e6fd0b
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