What could Brexit mean for investors?
As I write this at midday the stock market has recovered some of its poise. Financial stocks that were 25%-30% down at the market open have recovered somewhat to be only down 20%. The FTSE 100 opened down 8% and is now about 4.5% down. The markets have been expecting a “remain” vote all week and have been profoundly shocked by the “leave” vote. Sterling has had the biggest problems as on Thursday, with “remain” seemingly winning, at one-point sterling hit $1.50, however overnight as the results came in it fell as low as $1.35 and it currently stands at $1.38.
Short-term implications – recession and interest rates
Whilst the UK has been growing relatively strongly compared to many of our European neighbours, growth has still been anaemic and the shock of the result will most likely mean the UK will enter a recession. Anecdotally, the second quarter of 2016 (April 1 to June 30) has been slow. Talking to many managers they report their underlying companies have been cautious with future investment. These companies are likely to start spending and investing again, but the pick-up will probably be slow, leading to a weak third quarter and possibly triggering a recession (two quarters of negative growth is the technical definition of a recession). Whilst the Bank of England has few options available to them, a cut in the official base rate of interest from 0.5% to 0.25% or even lower is now a strong possibility. The next meeting is in a few weeks, however emergency action may well be taken to pre-empt and stimulate growth.
Whilst a shock fall in the currency isn’t great if you are about to head off on holiday, the impact of a weak sterling on the stock market, companies and your portfolio is quite interesting. For those invested in overseas assets already, a fall in the value of sterling increases the value of your overseas investments, therefore todays fall versus the dollar for example gives a degree of insulation from a fall when the US markets open later. This shows the benefits of having a globally diversified portfolio and not just a UK-focused one. Another linked factor is the impact on UK dividends. 2016 was looking to be a weak year for dividends, however many companies declare their dividends in USD dollars (HSBC and Astra Zeneca for example) and again, a fall in sterling increases the value of those dividends for UK investors. One final and probably more important point on a weak sterling is that it makes exports cheaper, giving a fillip to many UK-based manufacturing firms – we are world leaders in many sectors and this could be vital in the next few years.
Returning to my earlier point, the trajectory of rates in the UK is most likely down now and not up. Many commentators, including me, thought the US would increase rates again in 2016, possibly as early as July, however I cannot now see this happening.
As Neil Woodford put it recently, the UK’s long-term economic future would be largely unaffected by Brexit. Negotiations are clearly going to be tough both within the EU and with other nations, but countries aren’t simply going to stop trading with us. I recently saw that BMW sells over 800,000 cars to UK customers every year. Is Germany really going to stand by and play politics when we are such an important trading nation? However, it is fair to say that the long-term outlook is difficult to predict with the biggest potential concern in my view a possible disintegration of the EU. If that happened, all bets are off and there will be chaos in the financial markets. Will Greece, Portugal and Italy now decide that it’s worth the gamble of leaving and deciding their own fate? Will the Germans get fed up of bankrolling the southern states?
One longer-term factor to consider is the UK’s ability to self-finance the budget deficit. Thus far, we have been seen as a safe haven with global investors happy to bankroll the annual multi billion-pound deficit, however with political instability and uncertainty the UK may have to pay a higher rate of interest to tempt investors, thus pushing back the time frame for having a balanced budget.
Why we shouldn’t be worried
GDP – 1990 and 2014
As the above table hopefully shows, the Euro area has become far less of a force in global markets in GDP terms. In 1990, 26.2% of economic activity globally was in the Euro area, today that figure is 16.8%. At the same time, trade has picked up massively in other parts of the world notably Asia and Latin America. In 1990 Latin America combined with China and India accounted for 8.4% of global economic activity, today that figure is almost 24%. Whilst trading in a single economic bloc such as the EU is clearly beneficial in terms of ease of access, the UK’s ability to negotiate individual favourable trade deals with these growing and emerging nations is clearly huge. Whilst that will take time, we aren’t leaving the EU for at least 2 years, maybe longer.
What to do
There isn’t a simple answer to this. I have personally been buying selectively this morning as the price falls in some areas, especially financials have left some stocks looking very cheap. However, the most important thing to remember with investing is that it is for the long term and panic selling is not conducive to long-term profits. There is also little point selling after the event. The UK market is very well diversified globally with an estimated 70% of earnings coming from overseas. Even if the UK has a tough few years’ companies can still prosper.