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Brexit from an investors point of view

Leaving completely to one side the political arguments for and against Brexit, from an investor’s point of view, the most important questions are, “has Brexit caused investors any harm so far and is it likely to do so in the future”?

The consensus view of specialist UK and European equity fund managers is that, since June 2016, Brexit has undoubtedly suppressed equity markets both in the UK and mainland Europe. So why is this?

The answer is mainly due to the fact that domestic and international investors have preferred to ignore investment opportunities in the UK and Europe for the time being and have given preference to non-UK and non-European investment opportunities. The rationale being why bother to take on investments which carry political risk when you can avoid doing so.  This has had the inevitable effect of suppressing market valuations for all European equities including those from the UK.

We can see evidence for this in the fact that aggregate forward price to earnings multiples now stand at something approaching 11.  PE multiples this low indicates that UK and European equities are currently “cheap”.  The other way of expressing this is that markets have already priced in the consequences of maximum Brexit disruption.

UK and European equities are unlikely to fall by much due to Brexit even if it turns out to be more turbulent than everyone hopes.

Movements in currency rates of exchange are more concerning.  At the time of writing, sterling has depreciated against the euro by 17.7% since June 2016.  Most of the decline in the value of sterling against the euro occurred between June and October 2016 and thus far the effect has been to significantly stimulate exports which has been helpful to the economy and to lead to some price inflation which is unhelpful to consumers.  In the event of a “no deal” Brexit, we may expect sterling to depreciate by perhaps another 5%.  If Sterling depreciates by much more than that we could end up with significant short term imbalance in the economy due to price inflation.  A pre-condition for Sterling to fall by much more than 5% would be significant capital outflows from the UK – which is possible but not likely.

Highly productive parts of the UK economy have strong pricing power and, because of this, they would be relatively unaffected by currency moves in any direction as they will be able to simply adjust their prices in line with any currency movements.  What they would lose on Sterling depreciation, they would gain on re-pricing.

I said I would leave politics aside but one of the most significant risks of Brexit is a major party-political upset.

International and UK investors look on in horror at the idea that Brexit may lead to a Corbyn led Labour government.  Investors regard the Labour party in its current form as anti capitalistic and were such a government to form and then set a course for the country which investors fear, we can expect to see quite significant capital outflows from the UK.

Bullish Points

  • The price-earnings ratio at approximately 11 and dividend yields at properly 5% make the UK an attractive investment opportunity.
  • The UK economy benefits from an unusually high level of global earnings streams and this will cushion any adverse effects of Brexit.
  • Whatever the final Brexit outcome, we may expect an upward push on UK and European equity values as soon as the final situation becomes clear.

Bearish Points

  • Continuing uncertainty is the enemy of investors.
  • A Corbyn led government would drive investors away from the UK.
  • If sterling gets stronger in the wake of Brexit, this will push UK equity values downwards.
Posted in Markets