Europe’s Political and Structural Struggles

Brexit is getting a lot of headlines these days as the United Kingdom tries to figure out how to exit the European Union (EU).

The uncertainty surrounding the British relationship with the rest of Europe has clearly weighed on the U.K. stock market, as shown in the LPL Chart of the Day, and is one of the reasons why the British economy only grew at a 1.4% pace in the fourth quarter of 2018, based on Bloomberg consensus economists’ forecasts for gross domestic product. Consensus forecasts are calling for more of the same in 2019—not enough to get global investors excited.

brexit has weighed on the uk stock market

There are several possible paths for the U.K.-EU relationship after Theresa May’s plan was soundly rejected by the U.K. Parliament last week. One possibility is a messy exit without any agreement, a so-called “hard Brexit,” which we think will be avoided.

”Should the U.K. go down the hard Brexit path, the U.K. economy would likely slow further as EU trade uncertainty weighs on consumer sentiment and business investment,” noted LPL Chief Investment Strategist John Lynch. A second referendum on whether Brexit should happen at all is still on the table, as is a delayed agreement that could be reached after the March 29, 2019, deadline or even regime change.

Brexit is not the only risk in Europe for global investors to consider. Throughout the continent, a tighter regulatory environment and strict labor laws have restricted business growth, while the rise of populism has added obstacles. These challenges, in part, have made Italy’s debt problem trickier and pushed Germany to the brink of recession. Lackluster economic growth and heightened political risk drive our cautious tactical view on European equities. Because Europe constitutes the bulk of international developed markets, we maintain our cautious tactical view on developed international equities.

Emerging market (EM) equities look more attractive to us currently. EM offers stronger economic growth than developed economies and sensitivity to a likely pause in Federal Reserve rate hikes and to potential further weakening in the U.S. dollar, which are all generally good for EM stocks. We expect a U.S.-China trade agreement over the next few months, while in the meantime, China will likely launch more stimulus programs. Trade talks could always fall apart, but at current low valuations, we believe a fair amount of risk is already priced in. Both sides have strong incentives to get a deal done.

More on these topics in this week’s Weekly Market Commentary.


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