FTSE 250 could drop up to 10% in no-deal Brexit, says Morgan Stanley

(Sharecast News) - As Prime Minister Boris Johnson warned there was a "strong possibility" of a no-deal Brexit, analysts at Morgan Stanley considered the near-term implications of such an outcome, suggesting up to 10% downside for the domestically-focused FTSE 250 and a decline of as much as 20% for UK domestic bank stocks.
In an equity strategy note on Friday, MS said it still reckons a Free Trade Agreement is the most likely Brexit outcome. However, the lack of a breakthrough in the latest UK-EU negotiations points to an increased risk of a 'no deal' outcome, it said.

"Ahead of further negotiations this weekend we provide a tactical framework to consider the near-term equity market implications in the event of a no-deal outcome," the bank said.

As far as equities are concerned, Morgan Stanley said there has been a healthy consensus that a no-deal Brexit would be avoided, in fact the idea of such an outcome has been absent in almost all of its investor conversations this year. As a result, if it does occur, it would represent a "genuine and negative 'surprise' that markets are likely underprepared for".

MS said markets would likely react with "a controlled degree of disappointment" rather than distress, given that the wider global outlook remains healthy, with strong growth expected next year.

"In addition, those stocks most sensitive to Brexit also tend to be beneficiaries of the 're-opening trade' and the value rotation more broadly (neither of which are linked to Brexit), which should cushion the extent of any downside moves."

MS said the FTSE 100 is unlikely to see much of a reaction from a no-deal scenario, given the support it gets from a weaker pound. The top-flight index tends to gain when sterling weakens, as around 70% of its constituents derive most of their earnings from overseas.

However, the FTSE 250 could fall by between 6% and 10%, while domestic UK banks could see declines of 10% to 20%. MS said domestic banks would be likely to lead UK equities lower initially given their high correlation to sterling and UK risk premia in general.

"Fears of a subsequent move to negative interest rates could provide a further hit to sentiment," it said.

The other UK sectors most at risk would be insurers, real estate and housebuilders, MS said, while healthcare and consumer staples stocks and companies with high overseas exposure would be relative beneficiaries.

Banks were under the cosh on Friday, with NatWest 6% lower - also hit by a rating downgrade at JPMorgan - Barclays down 4.2% and Lloyds 3.9% lower. The FTSE 350 banks index was off 2.2% at 2,500.16.