Brexit, what Brexit? Investors have largely brushed off the impact of the largest political event in the European Union’s short history. The exit process will take years to unfold so the current relative market tranquility may be the most plausible outcome short-term but Brexit is real and undoubtedly there will be turbulence equally opportunity. Truthfully no one really knows what the relationship between the EU and Britain will look like one, five or ten years from now but it will be different, at the very least constitutionally. In such a scenario investors have no longer-term macro framework from which to reasonably forecast economic fortune for the region. Some investors will guess right, some wrong but that’s not the way we do things at C. J. Lawrence. When in doubt focus on company earnings. Brexit will have a major impact on some industries/companies and virtually zero impact on others. Our job is to identify those companies that we expect, with a high degree of confidence, to deliver superior earnings growth. Whether investing in Europe, the U.S. or anywhere else in the world we hold firm to this rule and believe such an approach is the only insurance policy for equity price support.
So what do we know so far about Britain’s status in the EU? Well in the ten weeks since the vote was cast Britain has already a new Prime Minister. For reference, Theresa May’s political fulcrum is right of Cameron and therefore pulls the conservative party towards conservatism, or to the right of the center ground that Cameron largely occupied over the past six years. The UK also has a new Chancellor, Phillip Hammond will be driving Treasury policy. May is traditionally a Eurosceptic who campaigned quietly for Remain leaving her ideally placed to succeed the premiership in the political embers of the of the Brexit vote. May will need all of her political experience to capture the most favorable outcome possible for Britain during EU negotiations.
May’s most important partner in these negotiations will be Angela Merkel. Trade between Germany and the UK is mutually crucial and Merkel, ever the pragmatist, has struck the most constructive tone among her European peers for a favorable exit outcome for all sides. The two major building blocks of the EU will be the main focus of negotiation: Trade and the Movement of People across the region. Unsurprisingly Britain, who invented Trade Liberalism, are anxious to maintain friction free access to European markets. However, Britain’s wish for sovereign control of immigration within the EU is the main stumbling block. European leaders see these two issues as a mutually exclusive requirement for EU status. There are some exceptions but Europe is determined not to set precedents that would encourage other partners to follow Britain’s exit if the terms are too sweet. These negotiations will take considerable time but we believe ultimately a satisfactory outcome will prevail.
So what to do now? Europe including the UK is in much better shape economically than it has been for years and has tracked our thesis for continued economic recovery. Equity markets across the region have been volatile, certainly more so than the U.S. and a valuation discount is evident when comparing similar European and U.S. companies. The currency environment particularly for the UK is even more favorable than it was when we banged the table last year and as an export region this will be a material tailwind. Add to this backdrop central bank action that is as aggressive as anyone would have possibly dreamt of two years ago with the addition of the Bank of England that surprised markets with its injection of funding. The result, Investors have a launch pad for equities that is unprecedented in economic history. Answer─Buy European stocks with sustainable quality earnings growth, watch valuations and avoid the traps.
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