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Investors anticipate softer Brexit; some spy opportunities in UK stocks

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Investors anticipate softer Brexit; some spy opportunities in UK stocks

The pound recovered lost ground Jan. 16 in the wake of the U.K. Parliament's rejection of Prime Minister Theresa May's plan for the country to leave the European Union. Market expectation is increasingly shifting toward a softer version of Brexit, and investors are highlighting opportunities in "undervalued" U.K. stocks.

The outcome of the Jan. 15 vote seemed to have been a foregone conclusion, emphasized by the scale of the defeat to May's proposal. Having lost ground against the dollar in early morning trading the following day, sterling recovered and was down just 0.01% as of 10:36 a.m. GMT at just under $1.29. Yields on 10-year U.K. government bonds — or gilts — rose six basis points to 1.32%.

The financial community is now placing more weight on the possibility of the U.K. remaining in a customs union as the Labour Party demands, or even a second referendum to reverse the process of leaving.

Kallum Pickering, senior economist at Berenberg, put the chance of a "semi-soft or soft" Brexit at 55%, but warned in a note following the vote that in the meantime "all hell could break loose" as warring factions in Parliament clash.

ABN Amro senior economist Bill Diviney sees another referendum as the "most likely route out of the impasse" given that it is clear that Parliament will not approve a no-deal Brexit. While a no-deal is the default outcome unless the U.K. and the EU can reach a deal, it is now being underplayed as a possibility.

"In any case, Brexit looks likely to be a softer one than Theresa May's deal, and perhaps will not happen at all," Diviney wrote in a research note.

Election spanner in the works

The opposition Labour Party tabled a no-confidence vote in the government which, should it be voted through by Parliament, could trigger a new government or a general election. This prospect, "in normal times," would "spook the markets" according to Nigel Green, founder and CEO of consultancy deVere Group, but investors appear unconcerned by this particular fork in the Brexit road.

"The longer the Brexit process is extended, the less chance of a no deal and greater chance there is of a second referendum that will reject Brexit, or a soft Brexit. This will please global financial markets and favor the pound and U.K. financial assets,” Green wrote in a note.

Increasingly investors are pointing to opportunities in U.K. stocks despite the continued uncertainty in the short term. "For long-term investors, this volatility does provide opportunities to buy domestic stocks — which were already at a significant discount to other markets — at more attractive levels,” said Terence Moll, chief strategist at Seven Investment Management.

Colin Morton, portfolio manager at Franklin Templeton Investments, suggests the U.K. is at an inflection point as average earnings rise above inflation. Data released by the U.K.'s Office for National Statistics showed consumer price inflation dropping to 2% in December, from 2.2%, as petrol prices and air fares fell.

Morton sees opportunities beyond Brexit, particularly in the stocks of housebuilding companies as the U.K. continues to suffer from a shortage of affordable housing. "Our analysis suggests the dynamics for the sector are very encouraging. Many U.K. housebuilding companies are in very rude financial health, often with net cash in the bank," he wrote.

But others are bearish about overall prospects. "The sad truth is that continued uncertainty has prevailed, and there appears to be no clear plan B," said Saker Nusseibeh, CEO of Hermes Investment Management.

DeVere's Green said money managers should remain defensive. "As the uncertainty rumbles on, portfolio diversification should remain the major strategy for investors."