(Bloomberg) -- The British Parliament may have delayed voting on Boris Johnson’s Brexit deal, but according to Morgan Stanley, there is enough of a reduction in political uncertainty to boost U.K. and European equities.
Morgan Stanley economists believe that despite the hurdles in Parliament, the odds are now in favor of the Brexit agreement being ratified by Christmas. And with the MSCI U.K.’s valuation at a 30-year-low to global peers, this bodes well for U.K. stocks.
U.K stocks are “becoming investable again,” said Morgan Stanley strategists, led by Graham Secker. “A reduction in Brexit uncertainty should lead to renewed interest (and re-rating) in U.K. equities, which are arguably one of the most unloved and undervalued areas of global stock markets.”
Johnson is undeterred after a Saturday vote forced him to ask the EU to extend the deadline for Brexit and on Monday will try again to put his proposal to the test in the House of Commons. The pound and the FTSE 250, an index made up mid-cap companies largely focused on the domestic economy, rallied last week on optimism that the U.K. won’t crash out of the EU without a deal and that an end to the three-year political saga may be near.
Morgan Stanley strategists see a further 10% upside for U.K. mid- and small-cap companies, adding that particularly the latter offer a better risk-reward profile due to their 10-year low discount to mid-sized firms.
Speculation last week that Johnson and EU leaders were closing in on a Brexit accord fueled a rally in European equities, with the Stoxx Europe 600 Index ending at the highest since May 2018 last Tuesday. European and U.K. stocks are the world’s most-underweight trades, according to the October Bank of America fund manager survey, with elevated political uncertainty part of the reason investors give for staying away from the region.
“An easing of Brexit tensions is also positive for the wider European equity market,” the Morgan Stanley strategists said.
Cheaper European equities, or so-called value shares, are likely to be the key winners from reduced Brexit risks as they have been following the pound lower over the past two years, said the analysts. Higher U.K. and European bond yields as a result of Brexit optimism should also help these stocks, leading Morgan Stanley to raise European banking stocks to overweight and cut consumer staples to underweight.
--With assistance from Lisa Pham.
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