Whilst there is much uncertainty following the referendum result, we look in this note at the possible outcomes of Brexit. The surprise vote by the UK to leave the European Union has resulted in volatility in global investment markets, which are widely believed to have been positioned for a ‘remain’ vote. This volatility was expected in the event of a ‘leave’ vote and should not be seen as chaotic: US Treasury Secretary Lew has described the market reaction as orderly. Indeed, whilst the market has fallen, the index average does not show the detail: some sectors have fallen sharply (such as housebuilders and banks) whilst others have risen (e.g. commodities companies).
There is good reason to believe that exit negotiations from the EU will be level-headed and result in a moderate solution. David Cameron has announced the formation of a ‘Brexit unit’ within the Civil Service, reporting to Oliver Letwin. Angela Merkel has stated she will seek to do a fair deal with the UK and EU officials have already indicated that the EU would favour a deal which re-admits the UK to the European Economic Area (EEA). However, whatever happens, there continue to be plenty of investment opportunities, and many of the potential investment positives from the days immediately following the result do not depend on the surrounding political processes.
As expected, the decision to leave the EU has caused a weakening of the pound. The media has treated this negatively. However, investors should bear in mind that in recent years many countries have been seeking to devalue their currencies because of the benefit to exporters. The UK can now enjoy the benefit and, given the current UK trade deficit, there is considerable potential to improve the UK trade balance. The UK stock market may also benefit from a weaker currency: with over 70% of Top UK 100 Companies earnings coming from overseas, companies’ bottom lines are directly improved by a weak pound. UK investors holding a diversified portfolio can also benefit as the value to them of foreign funds rises simply as a result of currency movements.
Whatever the result of the exit negotiations with the EU, the UK government will be in a position to negotiate trade deals of its own. This much is obvious if the UK severs all ties with the EU. However, it is less well known that EEA countries are also free to negotiate their own trade deals (although they sometimes work together to negotiate – there are currently 26 such deals – they do so voluntarily). It is generally acknowledged that the reduction in trade barriers which such deals bring about helps both individuals (who benefit from cheaper goods) and companies (who can sell to new markets without tariffs and enjoy increased consumer spending from wealthier consumers). This will be a long term effect (as it will not kick in until the UK has concluded Article 50 negotiations, expected to take about 2 years) but should ultimately help both the UK economy and UK stock markets.
Looking further afield, there is also potential for Brexit to improve the situation in Europe. The UK has long been considered one of the EU’s most recalcitrant members, holding back deeper political union. The Eurozone is currently the developed economy least far through the economic cycle, with the high unemployment which is holding it back being widely attributed to the problems of having a currency union without a political union. Whatever the nature of the UK’s future relationship with the EU, its departure from the union could permit further political integration with the potential for a resulting significant boost to growth.
Regarding investment strategy to make the most of these opportunities, Cantab Asset Management advocates the continued holding of a diversified portfolio, which should continue to include UK and European equities. This will provide protection from the short term volatility (Cantab Asset Management collective portfolios were up between 0.36% and 0.87% on Friday and between 0.51% and 1.34% on Monday, for a total increase over the two days following the vote of between 0.87% and 2.06%) as well as allowing investors to benefit from the potential long term investment consequences of the result.
Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.
