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How Brexit Could Impact U.K. ETFs in 2019

This article was originally published on ETFTrends.com.

Last year, European stocks and exchange traded funds were among the worst-performing developed markets assets. Amid contentious Brexit talks, U.K. stocks were among the worst offenders. The iShares MSCI United Kingdom ETF (EWU) slid 14.30% in 2018.

In December, the Bank of England cut their forecast for British quarterly economic growth in the last three months of 2018 to 0.2% from 0.3% and warned that conditions won’t likely change in early 2019. That could be a sign more challenges are ahead for U.K. equities and EWU this year. EWU, the largest U.K. ETF trading in the U.S., is up 4.20% to start 2019.

“While we identify a number of companies that could face long-term adverse developments following a no-deal Brexit, namely in the automotive space, we also see most disruptions as short term in nature and thus unlikely to materially alter our long-term views,” said Morningstar in a recent note.

Other Warnings

The Bank of England (BOE) recently warned that the global slowdown was pulling down Britain’s economy and the negative effects started sooner than expected.

In response to the weakness, the BOE decided to hold rates at 0.75% as expected. Central bank officials have stated that interest rates could move in either direction after Brexit based on the country’s ability to avoid any fallout from the Brexit.

“While a severe and prolonged downturn in the U.K. economy will have material implications for companies with significant revenue tied to the U.K. market, we should at the very least be cognizant of a potential contagion effect of a global recession, even if most forecasts we have seen do not consider that to be a meaningful risk,” said Morningstar.

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The $1.80 billion EWU holds 96 stocks and the targets the MSCI United Kingdom Index. EWU allocates over 38% of its combined weight to the financial services and energy sectors while the consumer staples and healthcare sectors combine for over a quarter of the fund's weight. Under the Brexit scenario, banks could be particularly vulnerable if they are not well-capitalized.

“Banks are particularly sensitive to unexpected shocks--like the U.K. tumbling out of the EU without any trade deals in place--which can often spark a loss of confidence and be the catalyst for a full-blown crisis,” according to Morningstar. “We also believe that the willingness of the Bank of England to provide short-term liquidity in the event of a crisis in confidence is vital support that will allow otherwise solvent banks to survive a short-term drought in liquidity.”

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