Finding Value in Brexit — Whatever Happens

The value-investor story for the United Kingdom is tied to the Brexit result, but not as portrayed in the mainstream media where coverage focuses on “hard” or “soft” versions of Great Britain’s exit from the European Union. For long-term investors, the Go or No Go investment decision is more about what economic structure is expected to result from the separation process, including an assessment of economic freedom.

Brexit poses two basic questions: How will the U.K. relate to the world, and how will its economy be positioned to capitalize on that relationship? Answers range from a disastrous hard Brexit (with World Trade Organization defined relationships, no special E.U. ties and government policies that constrain economic freedom) to the “Singapore on Thames” free-market model that retains E.U. special status while maintaining a free economy.

The 2019 Heritage Foundation’s Index of Economic Freedom ranks the U.K. seventh best among 180 countries evaluated. The index examines tax burden along with monetary, business, labor, trade and investment freedoms – and includes the important components of property rights and the rule of law.

Here are the alternatives for the planned Oct. 31 Brexit:

• Soft Brexit (same government): The governing Tory party attempts to improve upon the U.K.’s economic rankings by reducing taxes, cutting government spending and liberalizing trade relationships worldwide. This would provide a relative value opportunity as improvements in each of these areas would boost the U.K.’s economic freedom ranking, economic growth, and probably propel it more in the direction of Singapore (ranked No. 2).
• Hard Brexit (same government): The Tory government with a hard Brexit might create substantial lost output (GDP) and economic activity as the trade relationship with the E.U. dwindles, which is offset with improvements to taxes, government spending and liberalizing trade relationships around the world. Value investing would be very compelling in the aftermath of such an event.
• Soft or Hard Brexit (new government): A new government that reduces the U.K.’s economic freedom and global competitiveness may mitigate the near-term fallout with a soft Brexit but also make the U.K. relatively unattractive. A hard Brexit might create substantial lost output (GDP) and economic activity. It would only be compounded if a new government acted to reduce economic freedoms across taxes, business, labor markets, trade, and investment. A hard Brexit with constrained economic freedom would make the U.K. un-investible.