Last week saw the release of the draft withdrawal agreement between the UK and the EU.
While Prime Minister Theresa May has argued that this is "the best deal that can be negotiated", it has been criticised by both Eurosceptics and Europhiles within the Conservative Party, as well as the Democratic Unionist Party (DUP) MPs on whom Mrs May relies for her parliamentary majority. The Labour Party, the Scottish Nationalist Party (SNP) and the Liberal Democrats have indicated that they will vote against the deal. In addition, Mrs May's position has been undermined by resignations from her cabinet, abstentions by DUP MPs on Finance Bill amendment votes and calls from Conservative backbenchers for a vote of no confidence in her leadership.
So is the proposed withdrawal agreement dead? We don't think so – for two reasons.
Firstly, there is little time to renegotiate the proposed agreement and no appetite among the other EU members to improve the deal for the UK. If anything, demands by the UK for changes could result in other member states seeking revisions in areas that they believe are too generous to Britain. Already, France is pushing for guarantees on continued fishing quota sharing within British waters, while Spain wants a veto on the inclusion of Gibraltar in any future deal. However, the message from Michel Barnier, the EU's chief Brexit negotiator, is that he wants the UK's exit from the union to be orderly and lead to an "ambitious economic and strategic partnership". This suggests to us that Brussels will press member states to approve the proposed withdrawal agreement at the European Council meeting this Sunday, though this date could still slip.
Secondly, we think that, despite objections that Mrs May's deal is worse than remaining in the EU and does not offer the benefits promised by leading Brexiters, the UK Parliament will grudgingly vote it through in December or January. The logic here is that, while the majority of MPs may not like the deal, there definitely is not a majority in Parliament in favour of a 'no-deal' Brexit. Although Labour, the SNP and some Tory rebels would like to topple the government, they do not want to take the blame for causing the UK to crash out of the EU in a 'hard Brexit'. Recent comments from the health secretary, Matt Hancock; that he could not guarantee that people would not die as a result of a 'no-deal' Brexit serve to highlight the potential consequences of this course of action. Therefore, we think there is a good chance that MPs from different parties will ultimately come together to support the bill in the national interest, possibly after a number of votes and minor amendments.
If, however, Mrs May fails to convince enough MPs to back the withdrawal agreement but a 'no-deal' exit remains unacceptable to Parliament, a second referendum may be the only way out of the impasse. Although a number of MPs on both the government and opposition benches have called for a people's vote in recent days, we think it remains a low probability outcome, though admittedly one that brings with it the chance that the UK electorate reverses the June 2016 vote to leave the EU. While a new referendum might prompt Brussels to extend the Article 50 deadline for leaving, the European Parliament elections in May mean that the timescale for reaching a final agreement on the UK's future relationship with the EU could be too tight to be workable.
We are now more optimistic than we have been for some time that the UK can leave the EU with a deal that avoids further shocks to the economy. That said, we accept that the situation is dynamic and that there are no guarantees that common sense prevails. The prospect of a 'no-deal' exit has not been removed and, while we think there is a chance of a second referendum that results in the UK staying in the EU, it is still unlikely.
Turning to financial markets and recommended portfolios, the continued weakness of the pound and falls in the share prices of domestically focused UK equities suggest that investors are still expecting something close to a 'no-deal' outcome. Even if Mrs May's deal is not particularly good, if it gets through Parliament we could see sterling rally and equities that are sensitive to the health of the British economy, such as banks, retailers and housebuilders, regain their poise as investors who have allocated away from the UK start to return. We therefore believe that, despite the uncertainty that still surrounds Brexit, UK equities are attractive. Overseas equities, which have benefited in sterling terms from the weaker pound, could give back some of their outperformance relative to UK stocks if the pound rallies. However, we continue to believe that there are merits to having international diversification within portfolios.