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Investing in Europe: The Good, the Bad & the Ugly, Part II

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In a recent column entitled INVESTING IN EUROPE: THE GOOD, THE BAD & THE UGLY, I suggested that the ‘Ugly’ part of the BREXIT uncertainty in the United Kingdom was that the mess would continue beyond the deadline at the time.

Related: Europe: The Good, the Bad and the Ugly

Some of my readers thought that perhaps my analysis was a little off.

This is one of those rare occasions when being wrong would have been OK, but the ’ugly’ part, I’m afraid, continues.

In the meantime, British Prime Minister Theresa May has faced repeated defeats in her attempts to win approval from Parliament for the proposed terms of the divorce.

The failures left her with no choice but to obtain an extension of the deadline from the European Council. Somewhat surprisingly, she and the Council agreed on October 31 as the new deadline, which — as some wags have pointed out — might make for a Halloween BREXIT. Within that time period, May must find a compromise deal that will win the support of a majority of the members of Parliament, including disaffected members of her own Conservative Party (more formally called the Conservative and Unionist Party). Those familiar with British Parliamentary tradition can be forgiven for wondering whether Ms. May can manage that feat, since members of her own party have consistently voted against previous proposals for the break with the European Union.

These developments will lead to a chaotic political situation and a changing investment environment, explains Gavin Graham, London-based financial analyst and media commentator.

The extension makes it almost certain that May’s party will oust her, an outcome that becomes ever more real since local elections in the UK appear likely to be disastrous for the Conservatives. Party members will understandably view her mishandling of the BREXIT process as the cause.

Since the final vote on May’s replacement will apparently be in the hands of strongly pro-Leaver party members, the next Conservative leader will most likely be a Leaver, Graham suggests.

Possible candidates for the unenviable job of replacing her include Boris Johnson whom British wags have described as looking more prime ministerial than ever in his personal demeanor. The list also includes Home Secretary Sajid Javid, ex-BREXIT Secretary Dominic Raab and perhaps other Leavers.

Whoever wins will likely call a general election on the basis of a no-deal Brexit rather than remaining in a customs union. This will compel Labour under Jeremy Corbyn to clarify whether they want a customs union or something similar, which will risk losing Leaver voters in their traditional support areas of the Midlands and the North East. There is also the breakaway Labour faction called the Independent Group (TIG), which could split the vote. All of this makes for high level political theater but requires a high dose of investment clarity

From an investment point of view, Graham projects that the UK market will remain cheap until something is resolved. Meanwhile, investors are buying into global companies with a lower exposure to the domestic slowdown in Britain. That makes this an opportune time for value-oriented investors to dip the proverbial toe in these financial waters.

The political turmoil does hold some good news for investors, if only indirectly. The BREXIT saga will continue until at least October 31, and the unknown outcome will hamper British companies in their growth and initiatives, meaning that their share prices will likely remain generally static for the time being. In turn, that means that for those willing to venture in, there is time to observe, analyze and make a decision.

Executing this effectively means viewing the British stock market in four broad columns.

At time of writing, the first column consists of cheap stocks in pharmaceuticals (GlaxoSmithKline and Astra Zeneca), energy (BP and Royal Dutch) and materials (Rio Tinto and BHP), as well as in unfashionable sectors such as tobacco (British American Tobacco and Imperial Brands).

In the second column, other sectors, including consumer stocks such as Diageo and Unilever, are not cheap, but they remain less expensive than their U.S. equivalents, Graham says.

In the third column, investors might want to avoid British financial stocks and home-building companies due to their exposure to the domestic economy.

In the fourth column, which can best be described as ‘wait and see’, Graham includes industrials heavily exposed to exporting, which will be vulnerable if the current slowdown in global growth continues.

The BREXIT imbroglio has moved off the world stage for the time being and all bets are off as to what could happen next. However, investors may be able to work the breather to their advantage.

Disclosure: I do not hold any shares in any of the companies mentioned in this article and have no plans to purchase any of them.

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