Is Brexit Hype Correlated with Demand for ETFs?

Luis Aureliano  |

iStock.com/serggn

Written by Carolane de Palmas

Alexander Boris de Pfeffel Johnson, aka Boris Johnson, the newly appointed prime minister of the United Kingdom, has promised to take Britain out of the European Union by October 31, 2019.

He championed the Brexit cause, and became known as the Tory party's leading proponent of Brexit. His rise to the highest rank in the country was facilitated by Prime Minister Theresa May's decision to step down. The Conservatives failed to come to consensus with Labour, and May announced her resignation on June 7, but would continue on as caretaker prime minister until the new Prime Minister was selected.

With just four conservatives in contention for the position, the field was whittled down to just Boris Johnson and Jeremy Hunt. Some 160,000 party members were eligible to vote on the appointment of the next Prime Minister, and 87% of them (139,200 members) voted overwhelmingly in favour of Boris Johnson.

He captured 92,153 votes, or 66% of ballots cast, while Jeremy Hunt captured 46,656 votes, or 34% of the ballot. Boris Johnson’s campaign promise was all about leaving the EU, even without a negotiated settlement. This he promised to do by October 31, 2019. He became the official Prime Minister of the United Kingdom on Wednesday, July 24, 2019.

Boris Johnson recently lost the majority in the House of Commons after Tory MP Phillip Lee left the government, and after 21 MPs from the Conservative party rebelled against him to prevent a no-deal.

Last week, Boris’s own brother, Jo Johnson, resigned. Opposed to the Brexit, Jo Johnson said that he was ‘torn between family loyalty and the national interest’. Last week-end, Amber Rudd, British Member of Parliament and Secretary of State for Work and Pensions, also decided to quit Cabinet. She believes that the government isn’t doing enough to get a Brexit deal in place. Boris Johnson wanted to trigger an early general election to be able to restore his majority in the Commons. But this week, MPs voted against a snap election.


How are stocks and ETFs reacting to Brexit deliberations?

Prime Minister Johnson is preparing for what he calls the remote possibility of a no deal Brexit, aka Hard Brexit. He was quoted as saying: ‘I will take personal responsibility for the change I want to see… Never mind the backstop, the buck stops here.’ Therefore, the pound is strongly reacting to any news related to Brexit developments.

Source: TradingView - GBP/USD - Daily Chart on September 9th before the opening of the American session

Investors have wasted no time evacuating their funds from the UK to other safe-haven locales since Johnson’s appointment. The pound has been being sold en masse, depreciating 6% + against the USD at its lowest point since Boris Johnson become Prime Minister.

The fact that the GBP/USD exchange rate is plummeting comes as no surprise to currency traders and investors. The "Brexit Blowback" is regarded as one of the most significant geopolitical issues of our time, impacting markets in a dramatic and unprecedented way. It comes as no surprise that most punters regard Britain outside of the EU as less of a power player in the global economy.

Speculative concerns have driven bearish sentiment, as the GBP/USD reached its lowest levels in recent history. The impact of GBP weakness is not altogether distressing news for Britain's trading partners. For starters, UK exporters will benefit from foreign buyers purchasing more per unit of their currency than before, provided inflationary pressures keep UK prices in check. From a UK perspective, a weaker GBP is certainly starting to bite, with imports costing significantly more in GBP.

Currency traders, analysts, and economists alike warn of the perils inherent in a rapidly depreciating pound. For starters, many Britons who vacation offshore will be paying more for their holidays in GBP, even if EUR prices remain constant. Likewise, many household items used by people in the UK will cost more since they are imported from Europe.

While economists talk of a trade-off between imports and exports, Britain is a net importer, which means that the country will be worse off in the long run if continued negative sentiment vis-a-vis the Brexit saga continues to weaken the pound.

Nobody knows quite how deep the Brexit hole goes, suffice it to say that the UK economy will likely contract to the tune of around 2% (Oxford Economics). Scores of financial enterprises, banking operations, investment brokerages, automobile manufacturers, aerospace enterprises, and the like are already rethinking their plans to remain in the City of London. Many other destinations in Europe are being considered, such as Frankfurt, Madrid, Lisbon, Rome, and elsewhere.

Already, evidence points to rising inflation in the UK. The last Inflation Report (August 2019) published by the Bank of England declared that ‘CPI inflation was at the 2.0% target in June’. While inflation is expected to fall over the next six months, the only reason mentioned is because of ‘energy prices decline’. However, inflation is expected to pick up from next year, ‘as the impact of lower energy prices fades, sterling’s recent depreciation pushes up import prices, and domestic inflationary pressures rise.’

A weak GBP is typically associated with reduced spending domestically. Consumers are resisting the urge to spend on big-ticket items amid growing uncertainty at home. The UK and the EU are at a perilous impasse: EU officials declared that there has been no realistic proposition for the backstop plans, while the British PM is happy to crash out of the EU.

Source: Inflation Report - August 2019 - Bank of England

The Prime Minister may be calling the EU’s bluff by adopting a hardline approach to try and get his way. The financial markets have already voted; the GBP has been strongly rejected as other currencies are seen as more viable and worthwhile. Every time the UK Prime Minister scolds EU officials and threatens a Hard Brexit, the GBP edges a little lower.

As evidenced by the below chart of the FTSE 100 index, the leading UK stock market rallied following the appointment of the Prime Minister, but it has since come under sharp selling pressure in August. A cheaper GBP relative to foreign currencies means that foreign buyers of UK goods and services can increase their purchases, and drive sales for UK-listed companies.

Since 70% of the companies listed on the FTSE 100 index derive revenues abroad, earnings in foreign currency are worth more in GBP when exchange rates are taken into consideration. The domestic UK index, the FTSE 250 is comprised of UK businesses at home. These companies tend to feel the pinch with the lower purchasing power of UK consumers.

Source: TradingView - FTSE 100 - Daily Chart on September 9th

While stocks have certainly been subject to increased volatility since Prime Minister Johnson’s appointment, exchange traded funds have provided far more stability than individual stocks.

ETFs typically comprise multiple stocks, or bonds, and they are wrapped up in a package – typically an entire economic sector. ETFs can be traded like individual stocks, although they are passively managed investment options.

Many leading stock market tracking ETFs are available to UK traders, including those which track US bourses such as the S&P 500, the S&P 400, or the Russell 2000. One of the biggest ETFs is the Vanguard Total International Stock ETF [ (VXUS)] for emerging markets and developed markets outside of the US.

According to Barclays, the most popular ETFs in the UK at this time include the following:

  • ISHARES CORE FTSE 100 UCITS ETF GBP (DIST)
  • ISHARES UK DIVIDEND UCITS ETF GBP (DIST)
  • VANGUARD S&P 500 UCITS ETF
  • VANGUARD FTSE 100 UCITS ETF
  • VANGUARD FTSE 250 UCTIS ETF
  • INVESTO EQQQ NASDAQ 100 UCITS ETF

The ETFs are popular with UK traders at this time, since they provide broad exposure to the financial markets, and are not limited to the performance of UK stocks alone. They also charge significantly less than other, actively managed funds.

Because they track benchmarks (indices), they are regarded as passive since they mirror the performance of an entire index, sector, or collection of stocks. In an era of increasing instability vis-a-vis Brexit concerns, UK traders are looking to shore up their portfolios by diversifying into these potentially lucrative investment options.

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Carolane de Palmas holds a master’s degree in Corporate Finance and Financial Markets. She has experience trading a variety of markets and financial instruments, especially CFDs, leading her to produce content on various economic topics, specific trading strategies and specific financial assets for brokers and specialized media. She also worked for a Canadian hedge fund that specializes in alternative products (Altervest), where she was in charge of operations.

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Equities Contributor: Luis Aureliano

Source: Equities News

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer. The author of this article, or a firm that employs the author, is a holder of the following securities mentioned in this article : None

Companies

Symbol Name Price Change % Volume
VXUS Vanguard Total International Stock 52.31 -0.42 -0.80 1,277,728 Trade

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