The BREXIT vote whilst a surprise, was an eventuality planned for by the UK Government, and therefore is in a position of being well prepared to deal with the potential fallout from the vote to leave.
George Osborne has spoken already this morning (27.06.16) in calming tones, having spoken to the main world leaders and institutions such as the ECB and IMF over the weekend. It is worth stressing that the current situation is very different from the last major shock to stock markets in 2008 when a meltdown in the banking system was a real possibility.
Interestingly the UK stock market ended the week in positive territory and lost less that many global markets on Friday, especially in Europe with Germany losing over 10%. The weeks ahead will be the true test of the direction of travel and longer term implications for the UK.
Other ‘safe haven’ assets including Gold and GILTs also performed positively on Friday, as did a number of UK sectors with less reliance on UK earnings and the UK economy.
The biggest impact was seen in Sterling where this weakened against leading currencies, particularly the US$ which is looked upon as the ‘safe haven’ currency in times of uncertainty.
Ahead of the Referendum the majority of investment managers had positioned their portfolio’s defensively in terms of UK exposure, but there was not a rush to cash. The long term investment principles were very much followed, with diversification being the key.
So what now?
The ‘Leave’ campaign’s assertion that there will be no economic disruption from a leave vote is about to be tested. Investors have reacted swiftly and brutally to the surprise ‘Leave’ EU referendum result, clearly believing that material economic harm will result from the outcome. Whilst share price moves at the market open on Friday, 24th June were extraordinary, with severe dislocations apparent across many sectors, as the day wore on a more rational response was exhibited.
Companies in sectors with significant overseas earnings and little domestic exposure, such as pharmaceuticals, performed strongly closing up on the day as investors recognised the potential benefits of a weaker currency on their earnings. Stocks which are predominantly exposed to the domestic economy significantly underperformed the markets, however. As a proxy for this, it was interesting to note that whilst the more global FTSE 100 Index fell ‘just’ 3.1% on the day, the FTSE 250 Index, whose constituents are generally more exposed to the health of the UK economy, fell 7.2%, and it is perhaps these companies that may be worst effected over the coming months.
Overall, sectors most badly affected on Friday included banks (-10%), retailing (-10%), insurance (-11%), real estate (-14%) and homebuilding (-25%). Within each of these sectors there was a wide range of performances, none more so than in banks where the global banking giant, HSBC fell just 1%, whilst the domestically focussed Lloyds Banking Group fell 21% (despite having the protection of an exceptionally strong balance sheet). In morning trading today markets have lost c2% and a similar pattern has emerged with the biggest losers on Friday also showing the biggest losses today. Oil, resources and pharmaceuticals feature in the top five FTSE100 performers with gains of between 2.5% and 9.25%.
So is it credible to believe that the outlook for UK economic growth has deteriorated so sharply to justify these share price moves?
After all, at face value nothing will change in the short term as we will remain in the European Union for at least another 2 years and will have full access to the single market during that time.
-A weaker currency will import inflation making goods ‘on the shelf’, holidays and petrol more expensive to buy, thus diminishing purchasing power.
-Listed retailers tend to purchase a lot of their goods overseas and sell them in Sterling and therefore retailers’ margins will be under pressure from the weaker currency, whilst demand may suffer as consumers may have less disposable income to spend.
-Despite the weaker currency making the UK a more competitive place to manufacture goods for export, foreign direct investment will be curtailed due to uncertainty over future access to the single market. This could have an impact on employment and therefore consumer confidence.
-Diminished consumer confidence and headlines trumpeting an acceleration of house price declines in London (as employees in global financial service companies, buy to let and international investors shy away from the market) could undermine house prices nationally.
-In such an environment, banks may make it more difficult for borrowers to access mortgages and loans, although interest rates should remain lower for longer.
-Whilst occupational demand and supply for commercial real estate in London is tight currently, the demand side of the equation may soften thus reducing build activity and the upward pressure on rents. This may signal a turn in the cycle leading to reduced demand from investors and lower prices.
-If economic growth dips materially in the coming months as a result of the above, the tax take will undershoot whilst the demands on social payments will rise, thus exacerbating an already large budget deficit. A future government may have to take some unpalatable decisions concerning taxes and spending which could undermine growth still further.
If the above held true, then the immediate future for the UK economy would be bleak. Crucially as mentioned above, investors bought, rather than sold, gilts (UK government debt) on the day of the referendum result demonstrating that international investors believe that UK policy makers will continue to manage the economy prudently. These investors, therefore, are looking at the current weakness in Sterling as an opportunity to invest.
Therefore we believe that the moves in the share prices of many domestically focused, economically sensitive companies listed on the London Stock Exchange look overdone and there will be opportunities where the market has over-reacted to the referendum news.
It must be stressed, however, that confidence must be maintained and this will be testing/difficult where the two main political parties are in turmoil in terms of leadership and policy. Cameron will stand down as Prime Minister, and the Labour Shadow cabinet has seen a raft of resignations which have severely undermined Jeremy Corbyn’s position as Leader of the Opposition.
We are likely to see a rollercoaster ride over the coming weeks, but the key message is to keep calm and not make irrational decisions based on short term emotions.
If you would like to speak to one of our Brighton based Independent Financial Advisers about your portfolio we would be very happy to discuss the current position with you.
Ian Poysden – Managing Director