BofA Merrill Lynch BreX-files: A comprehensive view of post-Brexit Britain

BofA Merrill Lynch Global Research  have launched a new report about Brexit.

The BreX-files on post-Brexit Britain

Our UK Strategist, Tommy Ricketts, summarises in The BreX-files: Series Digest the findings of a series of interviews with BofAML’s UK-focused fundamental equity research analysts on post-Brexit Britain. In them, we take stock of developments 15 months after the vote. We also undertake a granular discussion of a scenario in which the UK leaves the EU on World Trade Organisation (WTO) terms and what this could mean for UK plc, companies, and the economy. While extreme, and not our base case, exploring this tail risk brings the challenges facing post-Brexit Britain into sharp relief.

 

9 things we think investors should know…

1.    Broking some UK-listed stocks is now harder, especially to international investors.

2.    A “bonfire” of red tape is hard to envisage given lead role of UK agencies.

3.    Onerous changes to ownership rules could stifle M&A activity.

4.    Bank of England (BoE) policies are propping up growth/ consumer cyclicals.

5.    Economic fallout from a WTO-exit is dependent on the “kindness of strangers”.

6.    Disconnect between listed UK and UK plc may widen further.

7.    Net outward migration post-Brexit is a major risk for companies.

8.    A WTO Brexit scenario would be least problematic for Miners/ Staples, most for Airlines.

9.    Fundamentals still trump Brexit as a driver for UK equity returns, for now.

 

The economic consequences of (less) migration

Immigration was the most common risk identified by sectors throughout the BreX-files interviews. A potential combination of an enforced immigration target, barriers to finding work, lower relative UK growth, and a weaker pound could discourage inward migration. Several years of flat or even negative net migration (from +300,000 pre-Brexit) could reduce the UK population by one million vs forecasts on a 3-4 year view. The implications would be far reaching for house builders, Banks/ Insurance, Real Estate, Retailers, Media, and Leisure stocks – little of which is currently in the price.

 

The Brexit Bull-Bear guide

We think the investment conclusion for UK equities is fairly clear for investors wishing to take a direction view on Brexit: the better the prospective trade deal, the more-GBP positive FX investors treat it, the more likely rates markets are to start pricing in BoE hikes, the stronger the case for rotating into UK consumer cyclicals and/ or long duration sectors, especially Real Estate and significant underperformers such as Media and Retailers. Investors bearish on the outcome, and that need to be invested in the UK, should seek shelter in Basic Resources, Oil majors, Consumer Staples, and Healthcare.

 

Contrarian trade: overweight Real Estate

Real Estate has underperformed, and is at a discount to, UK house builders and Banks post-Brexit despite similar macro drivers – BoE policy, bank lending conditions, gilts, UK domestic growth, and policy uncertainty – and sound fundamentals. If the discount is deserved then House builders/ Banks have more room to adjust downwards. If not, Real Estate is too cheap and should outperform either relatively or in absolute terms.
UK Equity Strategy: The BreX-files: Series Digest