- The U.K. Conservative Party won yesterday’s general election in a landslide, paving the way for approval of the withdrawal agreement allowing the U.K. to leave the E.U. with a deal in place by January 31, 2020.
- This would merely mark the end of Brexit “phase one,” however, as attention will now likely shift to E.U.-U.K. trade talks. Expect the 2020 Brexit environment to be similar to the 2019 backdrop, with hand-wringing over deadlines and multiple rounds of negotiations, suggesting U.K. economic growth is likely to remain subdued in 2020.
One Small Step for Manchester
The U.K. Conservative Party secured a sizable Parliamentary majority at yesterday’s general election, winning 364 seats in the House of Commons, far more than the 320 seats needed for a working majority. With a Conservative majority now firmly in place, we would expect U.K. Parliament to formally write into U.K. law the withdrawal agreement that takes the U.K. out of the E.U. by January 31, 2020. Per the E.U. “flex-tension” granted a few weeks ago, even if the withdrawal deal is ratified in early or mid-January, the U.K. cannot formally leave the E.U. until January 31. This description probably oversimplifies the next steps, and there are certainly more nuances to the process of formally ratifying and writing into law the withdrawal agreement. That said, we think market focus will largely shift beyond the more procedural steps that must take place over the next few weeks to pass the withdrawal agreement and more onto the next phase of the Brexit process: longer-term trade talks between the E.U. and U.K.
As a reminder, if the withdrawal agreement is ratified in its current form, the U.K. would officially no longer be a member state of the European Union starting on January 31, 2020, but from an operational standpoint, very little would change at first. The withdrawal agreement provides for a “transition period” starting on February 1, 2020 and lasting until December 31, 2020, during which there will still be tariff-free trade and free movement of people between the E.U. and U.K. This “standstill” in relations is designed to provide additional time to work out the specifics of a longer-term trade deal that will take effect after the transition period ends. As we and others have pointed out numerous times, 11 months is probably not enough time to agree on a longer-term trade deal. Moreover, in reality, the time available for actual bilateral trade discussions is far less than 11 months. The two sides must first set out their objectives in the talks, while there must also be time on the back end to ratify any trade agreement, a process which requires unanimous approval by E.U. member states, and of course U.K. Parliament as well. In addition, negotiators must decide by July 1, 2020 whether they want to extend the transition period by up to two years, another issue that will likely consume a fair bit of political oxygen. In that sense, the 2020 Brexit environment for the pound may look very similar to the 2019 environment—elevated pound volatility, concerns over deadlines and multiple rounds of negotiations.
Peering into the Abyss on Trade
The withdrawal agreement reached between the U.K. and E.U. a few months ago provides some guidelines for what the future of U.K.-E.U. trade will look like. Perhaps the most important provision is the protocol on Ireland/Northern Ireland. The protocol states that, after the transition period ends, a customs border will be put in place between Northern Ireland and the rest of the United Kingdom (i.e., England, Scotland and Wales). If the trade agreement reached between the U.K. and E.U. involves tariffs on goods of any kind, then a good shipped from England (no longer an E.U. member state), for example, to Ireland (an E.U. member state), will be tariffed when it crosses from England to Northern Ireland. The primary purpose of this provision is to avoid a hard border between Ireland and Northern Ireland. That said, in terms of the actual substance of any potential E.U.-U.K trade deal (i.e., tariff schedules, regulations on services, etc.), the withdrawal agreement says very little of substance about either side’s objectives in trade talks. At the highest level, the two sides basically have two options for how to conduct longer-term trade talks: modifying an off-theshelf agreement (“Norway style,” “Canada plus,” etc.) or drawing up a new bespoke agreement. Modifying an off-the-shelf agreement may be difficult given the sheer breadth and depth of economic and trade ties between the E.U. and U.K., and most indications from Johnson’s government have been that it will seek a more bottom-up, bespoke approach. Before these talks even begin, however, negotiators on both sides are likely to set out their objectives in trade talks. That said, as was the case with Theresa May’s “red lines” in the original Brexit talks, we expect these positions to become more flexible once negotiations begin. This early in the process, we think it is futile to spill too much ink debating what may or may not come of the talks, but we think there are three high-level points worth making regarding E.U.-U.K. trade talks.
First, Boris Johnson’s government is likely to take a hard line in its negotiating objectives. More specifically, the government is likely to prioritize reducing the free movement of people across borders and curbing regulation and oversight from E.U. authorities, while also emphasizing the need to have flexibility to negotiate free trade deals with other countries. Johnson may also take a hard line on the timing of a trade deal and delivering the “real” Brexit by December 2020, the current scheduled end to the transition period. In the end, this may be the red line that the government is most likely to back down on, although we would not be surprised to see his government retreat on other red lines as well as the talks proceed. Second, while much of the focus thus far in discussions around post-Brexit E.U.-U.K. relations has been on trade in goods, we would argue that trade in services is nearly as important and has thus far received relatively little attention. In 2018, roughly 40% of all U.K. exports of goods and services to the E.U. were accounted for by services exports. A large portion of these services exports are comprised of exports of law, consulting and financial services, all of which could face at least some increase in cross-border restrictions under any new E.U.-U.K. trade deal. In particular, the U.K. could lose its “passporting” rights, whereby U.K. domiciled companies (most notably banks) are able to operate branches across the European Union with minimal additional requirements, which could be a significant curb on U.K. services exports. More broadly, unlike goods exports, it may be more difficult to find replacement demand for U.K. services exports from other non-E.U. countries given the importance of geographical proximity on demand.
Finally, some version of a “no deal” Brexit is still possible. Indeed, if the E.U. and U.K. do not reach and ratify a trade agreement by December 31, 2020 and do not agree to extend the transition period, the U.K. will be out of the E.U. with no trade deal in place, conceptually similar to a “no deal” Brexit. The main difference between a “no deal” Brexit after the withdrawal agreement is passed is that the aforementioned protocol on Northern Ireland will be put in place, helping to avert a hard Irish border, while there will also have been an agreement by the U.K. to settle its outstanding financial obligations to the E.U. (~₤30B). As a technical note, if the two sides reach a trade deal by the end of the transition period but do not have time to ratify the deal, it can be applied in provisional form, and will only be rescinded if either side decides to vote the deal down.
Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.