So far this year I have avoided making any specific comments on Brexit. This is not because I don’t see it as an important issue, but rather because I never felt I had anything of much value to add to the debate. But now that we have the result, it seems sensible to ask what Brexit means for UK investors.
I’ll make two general remarks before moving on to some more specific investment considerations1.
Firstly, when thinking about the impact of Brexit on the UK economy, I see a big difference between the short term view (1-2 years) and the longer term picture.
It seems almost certain that the UK economy will face a prolonged period of uncertainty whilst the EU exit arrangements are negotiated. Companies may curtail investments or slow down their hiring. Consumers may rein in their spending or put on hold major spending decisions such as house purchases. It is hard to see how any of this can be beneficial for the economy. The depreciation of sterling is certainly a positive but I doubt this can offset the immediate negatives.
Longer term, the picture is far less gloomy. The UK has always been a vibrant and open economy. Brexit will be a legislative nightmare for those tasked with its implementation but ultimately new trade deals will be put in place and things will stabilise and eventually reach a new equilibrium.
This is not to say that everything is well with the UK economy. High indebtedness, low productivity growth and a dependence on easy monetary policy are structural problems that have not been properly addressed in recent years and will, in my view, continue to impede the UK’s progress. But this would be true inside or outside the EU.
Secondly, it is important to remember that stock markets detest uncertainty. They also have a habit or rapidly pricing in high profile bad news, as we are witnessing right now. Investors should therefore expect increased volatility and not be overly surprised if certain stocks or sectors fall to what seem like very low levels. This could also lead to some great investment opportunities, keeping in mind the longer term picture outlined above, although the uncertainty is likely to remain with us for at least two years while the EU exit arrangements are finalised.
More specifically then, what investment opportunities might there be for UK investors either now or in the near future? It helps me to think in terms of three broad groups of companies.
First there are the UK domestic companies, based in the UK and conducting the majority of their business within the UK. It is no surprise that this group of companies has been hardest hit in the initial stock market reaction, in particular those with early cyclical exposure to the UK economy such as banks, housebuilders and recruitment companies. Valuations are certainly starting to look compelling for many of these companies. For example, Lloyds Banking Group shares are now valued below tangible book value, which should be an attractive entry price for a conservatively managed bank with a huge and sticky market share. Selective buying of these companies should prove rewarding over the long term in my view. But just be prepared to average down!
In the second group are the exporters and overseas earners. These are international companies that have their head offices in the UK but earn most of their profits from overseas customers. To the extent that Brexit proves to be primarily a UK economic issue, these companies should be less affected than their domestic UK peers. Some may even be overall beneficiaries, particularly if they have UK based manufacturing as the depreciation of sterling makes them more competitive versus their international peers. Others may see notable translation benefits as their overseas profits streams are translated back into sterling. The opportunities in this area are most likely to emerge amongst the mid and small caps where share prices may become oversold amidst more general UK driven selling.
The third group are the big diversified multinational corporations, global, household names such as Unilever, British American Tobacco, Glaxosmithkline and Royal Dutch Shell. These companies are the least impacted by Brexit due to the globally diversified nature of their operations. When our team had a “Brexit pre-mortem” discussion two weeks ago – in which we attempted to lay out what we expected to happen in the stock market in the event of a Brexit and how we might benefit from it – one conclusion we came to was that this group of companies should in theory see their share prices rise on a Brexit due to the depreciation of sterling. However we thought in reality the “weight of money” selling pressure would push them down anyway, possibly quite significantly, and therefore this might present a buying opportunity. Unfortunately, the stock market appears to have been pretty efficient thus far as most of these shares are indeed higher than they were pre-Brexit. Whether this remains so in the coming days and weeks remains to be seen.
In conclusion, as things stand today, I don’t see Brexit as a reason for investors to panic. It is certain to continue to have some short term impact on the UK economy and beyond but I’m not sure the longer term picture has really changed much. Stock markets are discounting machines, so much of the bad news will already be priced in, whilst the impending uncertainty and associated volatility may well lead to some attractive long-term investment opportunities. Of course the economic picture could change for the worse (or better), either in the UK or elsewhere, but for now I intend just to keep calm and carry on investing.
1. This is no recommendation to buy or sell any particular security