Following on from our initial note on Friday regarding the UK Referendum, we look at some of the major developments over an historic few days.
UK Political Situation
The political uncertainty is extraordinary, with many questions yet to be resolved, including who will replace David Cameron and lead the exit negotiations. The current favourites are Boris Johnson and Theresa May, with a new Prime Minister to be in place by 9th September 2016.
The leadership contest should mean there will no immediate trigger of Article 50, with Prime Minister Cameron confirming that negotiations will have to be headed by the new PM. If Article 50 is invoked, and there has been some speculation that it might not be, there is a two year time frame for the UK to leave the EU, although in practice it may take longer than this.
The Labour party is possibly in even more turmoil with Jeremy Corbyn losing a no confidence motion with more than 80% of Labour MPs voting against him. Many of Labour’s Shadow Cabinet have now resigned over the past three days, although Corbyn appears to going nowhere. Another leadership election is very much on the cards, with Corbyn standing again and he has the support of the trade unions and a large number of party members, which could make him very difficult to dislodge.
A further complication is the fact that Scotland are seeking discussions about staying in Europe and a possible second independence referendum. There is also a concern that other EU member states may demand their own referenda on continued membership.
Impact on Markets
There has been a great deal of commentary on what the potential negatives of a Brexit from the European Union, with some suggesting “Armageddon”. These have been well documented in the press, but there are positives that are worth bearing in mind.
Most obviously, markets move quickly to discount the perceived risks, and the falls of Friday and Monday have left many stocks looking both cheap and oversold, which Tuesday’s rally seemed to confirm. Sterling’s fall should have been a net benefit for investors, especially with overseas holdings, as should any further falls in interest rates. Monetary policy should remain supportive with an interest rate cut in August looking likely in the UK, whilst the European Central Bank’s bond buying programme might well be extended. Even a rise in inflation, providing it is short term, might be regarded as a helpful development.
Despite the political and global market turmoil, most equity market indices have been fairly resilient. In particular, some of the UK larger companies with overseas earnings have performed very well over the past three trading days since Brexit was confirmed. Some stocks have seen gains of over 10%, for example. UK banks, insurance companies and house-builders have seen significant falls, in excess of 30% in some cases, but we feel some of these stocks have been oversold.
Small and Mid-cap sectors were hit harder than the FTSE 100 by the Brexit vote on Friday, with the FTSE 250 down over 10%, principally because these stocks tend to be more domestically focused. However, Tuesday (and at opening this morning) saw a rally in virtually all sectors and some of the losses have been erased.
As mentioned above, the fall of Sterling against virtually all major global currencies has provided our investment strategies with welcome gains, with funds invested in Asia, the United States and even Europe showing strong gains, despite equity markets in those regions falling.
Our investments in UK fixed interest investments have proved to be very resilient and in some cases have shown some increases over the past 3 days. The worst performing areas of our investment strategies have been the more domestically focused funds, particularly UK Mid-cap and Small-cap stocks, and UK commercial property funds, as the fear of an exodus of foreign investors and a UK recession (unlikely in our opinion) has seen some investors heading for the exits.
The advantages of having well diversified investment portfolios with a broad range of asset classes has never been more important than it has been over the past few trading days. We have been monitoring the performance of client portfolios closely, and diversified portfolios with overseas holdings have been shielded from a lot of the reported turmoil on equity markets, primarily because of the fall in Sterling.