Brexit’s impact on European investing very much depends on the type of Brexit that is ultimately implemented both in the short term – in the form of any withdrawal agreement – but also in the longer term post-transition.
Clearly, at this stage everything remains very unclear, but we can outline some broad potential outcomes and consider the possible impacts in each case.
First, however, we should consider the parts of the European economy impacted by Brexit and their importance to the stock market.
Impact on markets
The two primary areas of impact are tariffs and regulations that enable products to cross borders without hindrance.
A simple example of this is the recent spat on chickens with the US, where Europe does not allow chickens to be washed in chlorine, but the US does.
This regulatory convergence is an important trade facilitator.
While the media tends to focus on areas such as food and tourism, from a European market impact view, these are not of any huge importance.
The most impacted sectors from a stock market point of view are manufacturing and finance.
Most prominent is obviously manufacturing, where supply chains for many European companies are very integrated across borders and, for many companies, the UK is a very significant end market.
It pays to bear in mind that these days supply chains are integrated globally and it is just the UK to Europe part of that supply chain that is potentially impacted.
Of particular importance is the automobile sector, a sector in which the UK is not only a key supplier, but, of particular relevance, an important end market.
Another area to consider is the aerospace sector, where again the UK is a major part of an integrated supply chain.
Finance future unclear
Next in importance is services, particularly financial services. Here the impact is much less clear; as in the consumer sector, local regulations still dominate and there is very little business done across borders.
However, in wholesale markets, London dominates and has done for many decades. Any disruption of access to the UK’s wholesale capital markets for European companies would be hugely damaging, but also highly unlikely to occur.
When we consider the importance of these sectors to the European stock market we find that the impacted areas are of very low importance, and while the German auto manufacturers are of large importance to the German economy, their stock market importance is pretty irrelevant, with the largest company Daimler accounting for less than 2 per cent of the Euro Stoxx 50 Index.
This reflects the fact that the industry has a low profitability and low valuations even without any impact from Brexit.
Perhaps more important might be the impact of higher value-added manufacturing such as aerospace, where the imposition of tariffs and regulation would impact prices. However, this is an area of strategic importance where substitution is difficult and time consuming, so near-term impacts are likely to be minimal.