Global markets have been preoccupied with the US-China trade war for months now. Lately, the protests and riots in Hong Kong (one of the world’s financial centers) have added even more uncertainty into the mix as the major city rallies against Chinese control.
But a third story may be just as important to your investments.
It’s a story that is often underplayed by the mainstream financial news.
And this year, Halloween will be scary for another reason. That’s the date set for the United Kingdom to leave the European Union. And currently, that divorce is looking like it might happen under one of the worst-case scenarios.
Let’s look at how we can prepare ourselves.
The Brexit Mess Could Have Three Outcomes
Brexit – the shorthand for the United Kingdom exiting the European Union (EU) – is set to hit on October 31.
Now, the original decision to leave the EU was made by British voters in a referendum three years ago in 2016, during one of the first “populist uprising” votes. But through a convoluted, confused, and badly managed (on all sides) process, Brexit has been delayed time and time again.
No one seems to be able to agree on how Brexit is to be implemented. Issues such as trade between the EU and UK were supposed to be settled in a deal before Brexit happened. But getting a deal that everyone likes has proven impossible.
On May 24th, Theresa May announced that she would resign as Prime Minister if she couldn’t push through a deal through the British Parliament. She resigned on June 7th after she could not convince Parliament to accept her version of that deal. The main sticking point was what to do about the border between Northern Ireland (a part of the United Kingdom), and the Republic of Ireland (a member of the EU).
As both Ireland and the UK are members of the EU, there are currently no border checks, nor any other obstacles to travel or trade across this border. In fact, you might not even notice that you’re leaving one country and entering the next.
That has taken the wind out of the sails of those who used to fight in “the Troubles” – the civil war between those who wanted Northern Ireland to stay in the UK, and those who wanted it to join Ireland.
May’s successor as Prime Minister, Boris Johnson, pledged to renegotiate her deal, but those negotiations have failed. And as British and EU law currently stand, the UK is set to automatically leave the EU on October 31 whether there’s a deal or not.
That’s where the three “kinds” of Brexit you may have heard of come in: “soft,” “hard,” and “no-deal…”
Uncertainty Over What’s Next is Already Hurting Stocks
These three phrases describe different deals the UK would leave the EU with. Under a “soft Brexit,” the UK would stay in the EU’s common trade and customs zone, with trade and travel mostly unchanged.
For most companies and individuals, a soft Brexit would not change much at all. This would be the least disruptive to markets. Theresa May’s deal would have been a hybrid soft Brexit.
“Hard Brexit” is the name for what would happen if the UK left the EU without a trade deal in place. The EU is the UK’s largest trading partner, so this would be very challenging for British companies to adapt to.
That’s especially true since, under a hard Brexit, this transition from free trade with the EU to a no trade deal would happen immediately on midnight, October 31, without any transitional period to ease companies in.
That’s a lot of uncertainty, and as we know, uncertainty is what markets like the least. The turmoil in the markets when this happens could hit select stocks hard.
And right now, the UK is set to leave the EU on October 31 without any deal at all – a “no-deal Brexit.” That’s just another form of hard Brexit.
That’s why protecting your portfolio from companies based in the UK, or with a lot of exposure there, right now is crucial. Because the closer we get to Brexit, the riskier staying in these stocks is going to be.
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But that’s not all. Once the UK leaves the EU, it must begin negotiating trade deals with all the countries around the world it previously traded with under EU rules.
Probably the most important trade deal would be with the U.S. Here, British companies may well lose out again.
After a hard Brexit, the United Kingdom will be desperate for a trade deal with a major trading partner. Since negotiations failed with the EU – it’s a “hard” or “no-deal” Brexit, after all – the UK would be itching for a deal with the U.S.
But President Trump likes to play hardball in trade negotiations and might not go easy on the British.
Now, the British Parliament just passed a law requiring the Prime Minister to ask the EU to postpone Brexit again.
Or that’s the plan, at least. As the three-year-long Brexit saga has shown, plans tend to be delayed and diverted.
And that means more uncertainty, with companies at risk of losing out over Brexit already facing turmoil in the markets.
Here’s how to protect your portfolio from this mess…
Avoid These Six Stocks Ahead of Brexit
As one of the world’s main financial centers, a number of financial companies would be hurt by a hard Brexit. Bank of New York Mellon Corp. (BK), for example, gets 15% of its revenue from the UK.
HSBC Holdings plc (HSBC), one of the world’s largest banks, is headquartered in London and originates from Hong Kong, putting it at risk from both a hard Brexit and the fallout of the demonstrations in Hong Kong. The bank is already moving 1,000 employees from London to Paris, and expects to pay up to $300 million for that relocation alone.
According to its own estimates, HSBC could lose $1 billion in revenue over a hard Brexit.
With the London Metal Exchange being the world’s largest exchange of gold and many other metals, gold mining companies may also be in for a rough ride. Newmont Goldcorp Corp. (NEM) is especially at risk, with 75% of its revenue coming from the UK.
Other companies with a large exposure to the UK include eBay Inc. (EBAY) and PayPal Holdings Inc. (PYPL). eBay is a very popular way to shop online in the UK, and it uses PayPal as its payment system. Under a hard Brexit, the lack of a trade deal with the EU would lead to difficulties sending payments and goods across the border – hitting the revenues of both companies hard.
British airlines such as Ryanair Holdings plc (RYAAY) would also suffer when travel to and from the UK becomes more difficult.
Here’s a chart showing how all of those companies (as well the SPY) have fared since Theresa May announce she would step down:
You can see that four of the companies are under water since then, despite the UK rebound that has happened in the last week and a half.
Ebay has found some footing, and Newmont mining has powered up along with the big jump in gold prices. I’d be leery of Newmont holding those gains if Brexit issues can’t be worked out.
Meanwhile, U.S.-based competitors to many of these companies may well prosper under a hard Brexit, especially if a U.S.-UK trade deal is favorable to America.
I’ll talk more about the U.S. sectors and stocks in a future article. Until then, I always love to hear from you. Send me any questions or comments you have below.
Great trading and God bless you,
D.R. Barton, Jr.