Brexit Means Markets Turn Bearish on U.K.

Matthew A. Winkler is a Bloomberg View columnist. He is the editor-in-chief emeritus of Bloomberg News.
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When U.K. voters decided last June to leave the European Union, global investors anticipating the opposite result wiped out billions of pounds in the currency market. Sterling plummeted a record 8.05 percent to a 31-year low.

QuickTake Brexit

It's been seven months since those British voters narrowly rejected the view of prime ministers, presidents, finance ministers, business leaders and economists that exiting the EU would hurt the U.K. When Theresa May succeeded David Cameron as prime minister she said, "Brexit means Brexit" and committed her new Conservative Party government to severing its ties to continental Europe after more than four decades.

Plenty of commentators still predict that Brexit will prove relatively benign, and say it's likely to do more damage to the EU than to the U.K. Already, though, there's unmistakable evidence that Brexit has been bad for Britain.

A month after the referendum, the U.K. economic outlook suddenly darkened. The consensus forecast of gross domestic product growth has plummeted more than 75 percent, to a low of 0.5 percent this year, from 2.1 percent when the polls opened for the Brexit vote on June 23, according to data compiled by Bloomberg. Economists also lowered their forecast of growth in 2018 to 1.3 percent from 2.2 percent.

Future Shock
Projected U.K. GDP growth, year-over-year
 
Source: Bloomberg

If these forecasts prove correct, the U.K. could find itself struggling with the second-slowest annual growth rate among Group of 20 nations (after Japan) as soon as the fourth quarter of this year.

Anemic growth would be a throwback to Britain's go-it-alone years. Prior to joining the European Economic Community in 1973, the U.K. had the slowest GDP growth in the Group of Seven, including Japan, Germany, Italy, France, Canada and the U.S. The order reversed during the ensuing 44 years, with Britain rising to No. 1 in the G7 in average annual GDP increases. That enabled Brexit opponents to argue that being in the EU didn't prevent the revival of the U.K. economy. 

For most of the 21st century, investors have displayed their confidence in the U.K. by keeping the value of British government bonds high. Since the referendum, though, those British gilts lost 13 percent of their value, becoming the worst investment after Japanese securities in the Bloomberg Barclays Global Aggregate Treasury Index. British bonds underperformed global government bonds by 9.5 percent, the largest gap since 2008, when British banks were rescued from insolvency during the financial crisis and gilts suffered a 27 percent deficiency compared to the world benchmark. That was the only period when U.K. debt was so inferior, according data compiled by Bloomberg since 2001.

The pound hasn't recovered from the slide since June.

Bottom of the Heap
Change in value since June 23, 2016, in U.S. dollars
 
Source: Bloomberg

The currency has also become unstable. Foreign-exchange traders expect its value to keep fluctuating, creating the biggest gap in implied volatility between the pound and euro since 1999, when the euro was introduced, according to data compiled by Bloomberg. To be sure, the market anticipates the pound rallying as much as 26 percent in coming years and returning to its pre-Brexit high of more than 1.50 by 2020, according to Bloomberg data.

But none of that predicted rebound in foreign exchange is apparent in the stock market, where British companies no longer retain their value when compared to European counterparts. Before the Brexit referendum, investors were paying 9 percent more to buy shares of the 100 companies in the FTSE 100 Index than for European companies with comparable earnings potential. That was the widest gap between British and European share values since Bloomberg began compiling such data in 2005. Since then, this premium based on price-to-forward-looking earnings reversed to a 5 percent discount.

Expectations Gap
Difference paid to invest in U.K. stocks versus European ones
 
Source: Bloomberg
Ratio of price to forward-looking earnings, FTSE 100 Index versus STOXX Europe 600 Index

The declining relative value of corporate Britain accelerated during 2016's final quarter, when companies announced plans to spend a record $87 billion consolidating. That's mostly because British shares were worth less to domestic acquirers than they cost on public stock exchanges. This discount, the first in 12 years, widened to 22.5 percent this year from 4.7 percent two months ago, according to data compiled by Bloomberg. As corporate Britain cheapened, foreign companies remained skittish. They spent the least amount of money for publicly traded U.K. firms since 2012, even as the premium for these assets compared to the market price declined to a 12-year low of 13.2 percent.

Housing, a traditional bellwether of confidence in the British economy, isn't behaving like its former robust self. While U.K. homes appreciated an annualized 4.3 percent in January, their value rose at the slowest pace since 2015 and well below the 20-year average of 7.3 percent prior to 2016, according to Bloomberg data. Housing prices in the EU, by comparison, rose at the same annualized rate of 4.3 percent in the third quarter, but that was the most since 2007 and they appear poised to outperform the U.K. market in the months ahead. 

For much of the century, the U.K. has been where the jobs are in Europe. Brexit is changing that reality, too. 

After dropping to an 11-year low of 4.9 percent last year, the jobless rate will increase to 5.2 percent in 2017 and 5.5 percent in 2018, according to forecasts compiled by Bloomberg. 

That would be the clearest signal that the best has come and gone after Brexit.

(With assistance from Shin Pei)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matthew Winkler at mwinkler@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net