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Matt Winkler
Matt Winkler
Articles (113) 

A No-Deal Brexit Is a Contrarian Buying Opportunity

Panic selling in UK equities could ensue if Prime Minister Theresa May's Brexit plan fails to pass Parliament on Tuesday

January 10, 2019 | About:

Traders in British stocks are going to have a field day next week.

Watch movement in the iShares MSCI United Kingdom ETF (EWU). British Bank stocks like HSBC (NYSE:HSBC), Barclays (NYSE:BCS) and The Royal Bank of Scotland (NYSE:RBS) could get especially volatile around the Brexit vote in Parliament scheduled for this coming Tuesday, Jan. 15. Depending on what time the vote is actually held, the real big moves could be postponed until Wednesday, but big they will almost certainly be, in either direction.

The final vote on Prime Minister Theresa May’s Brexit deal with Brussels could be the difference between a clean Brexit, in which trade agreements between the U.K. and what remains of the European Union are in place, and a messy no-deal Brexit, which is essentially uncharted territory. Agreements on how to shuttle goods and capital back and forth between the U.K. and EU will have to be rewritten pretty much on the fly.

Traders can zoom in on this week specifically. There will likely be no more postponements, because the vote was already postponed once back on Dec. 10. It won’t be postponed again, considering that the legal deadline for Parliament to vote on May’s deal is Jan. 21.

It is looking increasingly likely that May’s deal brokered with Brussels will not pass the House of Commons, which is the very reason that the vote was postponed last month in the first place. If the deal does indeed get voted down, U.K. stocks will tank, especially bank stocks. If it passes, they will skyrocket, as all of the concentrated uncertainty as to what happens after a no-deal Brexit would evaporate instantly. A torrent of buyers would flood the London Stock Exchange trying to get in front of every other buyer.

For conservative traders who would rather not place bets on the outcome of the vote itself, an interesting contrarian way to play this vote is to actually buy if May’s Brexit deal fails, and here’s why. First, if it passes, retail traders may not be able to get in quickly enough. Any initial jump could quickly fade within days, as nothing materially would change, except perception, and that doesn’t last very long.

But if the vote fails, we’re likely going to see an overreaction to the downside for days or weeks. There are two basic scenarios that could unfold from there. First, a Hard Brexit could actually happen by March. Much of the European media is preaching doomsday on a no-deal Brexit, which would stoke panic in U.K. stocks.

However, any period of trade chaos in all likelihood won’t last that long. Trade between the U.K. and Europe is too valuable to leave in limbo for any extended period of time. Trade in 2017 between the two, for example, amounted to £615 billion, or $786 billion. Speaking just in terms of safety and human life, it is untenable to suspend economic activity of this magnitude indefinitely. That’s why it is very likely that in the days and weeks that follow a failed vote to Hard Brexit scenario, arrangements will be made to mitigate any catastrophes.

In the ensuing chaos, market forces would compel both sides to come to terms with reality and work something out. That’s why, after the initial plunge, U.K. stocks are likely to claw back as Armageddon-themed headlines become more realistic and level-headed. Trade between the U.K. and EU is not going to end. It will merely be disrupted temporarily.

The other possible scenario after a failed vote would be a second Brexit referendum, which in itself would push U.K. stocks back up that much quicker. Recent polls suggest that the Remain camp would win a second referendum by 46-39%.

A failed Brexit vote as a buying opportunity is quite the contrarian position, certainly in the context of the doom-and-gloom headlines that will surely worsen if Tuesday’s vote actually fails. Who wouldn’t be selling in such a scenario?

The relevant question then is one of time horizons. If a Hard Brexit actually happens, it would take longer for U.K. stocks to recover, perhaps months. If we see a second referendum and Remain wins after a failed vote, the recovery would probably take only weeks. Either way, a failed Brexit vote Tuesday looks to be a good contrarian buying opportunity in U.K. equities.

Disclosure: No positions.

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