With the Brexit process likely to be taking place by the end of March 2017 under the supervision of British Prime Minister Theresa May, it becomes all the more relevant to mull over the aftershocks and the global repercussions of this historic event. We note that it was in late June when Britons decided to part ways from the EU by a referendum (read: UK Votes for Brexit: ETFs Winners & Losers).
Forget about the globe, the exit is sure to have a sweeping impact on the UK economy itself. As per the Treasury, a 'hard Brexit' – implementation of firmer regulations on EU immigration, exit from the EU single market and imposition of trade barriers between the two parties – may lead the UK to lose about £66 billion (per year) and reduce its GDP by nearly 9.5% after 15 years.
What Do Current Economic Readings Say?
First of all, investors should note that the impact of the Brexit has so far been currency-related. In June, the British pound dived to a three-decade low and recovered in the ensuing period only to sink again to a 31-year low as soon as talks of materialization of Brexit resurfaced.
David Davis, the Brexit secretary, noted that “there will be lots of speculative comments in the next two-and-a-half-years that will drive the pound down and up and down and up and there is little we can do about that.” Pound ETF CurrencyShares British Pound Sterling ETF (FXB - ETF report) was down 9.1% in the last one month (as of October 11, 2016) (read: Pound ETF Plunges: More Sell-Off in the Cards?).
But most interestingly, the UK economy is not following the course of its currency, neither currency-hedged UK ETFs. Notably, while most regular UK ETFs including iShares MSCI United Kingdom (EWU - ETF report) were down in the last one month, currency-hedged UK ETFs advanced in the same timeframe.
First Trust United Kingdom AlphaDEX Fund (FKU - ETF report) was the biggest loser in the pack having shed over 8.5% in the last one month (as of October 11, 2016) while WisdomTree United Kingdom Hedged Equity ETF (DXPS - ETF report) added over 4.2% gains during that period (read: Europe After Brexit: 5 Keys to Investing With ETFs).
Can Currency-Hedged ETFs Keep Up the Run?
The strength in currency-hedged ETFs is perhaps here to stay. This is because Britons are showing no signs of submissiveness. Consumer confidence in the UK economy topped to the highest level since 2014 notwithstanding Brexit woes, per Barclaycard.
Consumer spending in September was 4.2% higher than the year-ago period. The group also indicated that 57% of “people surveyed said they expect to spend money on 'Black Friday' and 'Cyber Monday' sales next month.” Visa also justified the fact by saying household spending grew 2.4% annually in September.
UK factories logged the quickest growth in two years. Export orders leaped at the fastest rate since January 2014, probably aided by a weaker pound. Employment grew for two months in a row.
Business confidence was 112.4 in September, up from 105 in July and 109.7 in August, as per the source. The September level is a little lower than June’s score of 112.6. This indicates that business confidence is gradually regaining lost ground. A figure above 100 reflects a positive outlook.
UK's GDP grew 0.7% sequentially in Q2, higher than a 0.4% rise in the previous period. The growth rate represents the 14th successive quarter of growth with both household spending and fixed investment remaining steady.
As per an analyst, GDP growth is expected to be in the region of 0.2-0.3% in the third quarter and the economy is far better-placed than it was previously feared. There are various other views – upbeat to modest – but hardly anyone apprehends a recession.
Though IMF reduced Britain’s 2017 growth forecast to 1.1% from 1.8% expected in 2016 (down from 2.2% in 2015), it is still in the vicinity of the advance economies’ expected growth rate of 1.6%. In fact, IMF noted that “Britain will be fastest growing G7 economy this year.”
ETFs to Play
Investors can thus play surging currency-hedged UK ETFs a little further. Apart from DXPS, there are two other options, namely iShares Currency Hedged MSCI United Kingdom ETF (HEWU - ETF report) and Deutsche X-trackers MSCI United Kingdom Hedged Equity ETF (DBUK - ETF report) . DXPS, HEWU and DBUK have a positive weighted alpha of 15.00, 13.70 and 14.50, respectively. A positive alpha hints at more gains (see all European Equities ETFs here).
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