UK equities
24 Oct 2016 | By Richard Buxton

Brexit means Brexit: and uncertainty means opportunity

Even the best-laid plans can sometimes go awry. My thinking prior to the EU referendum vote on 23 June was broadly this: a stock market wobble in the weeks leading up to the event, but the vote would undoubtedly be Rema

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Even the best-laid plans can sometimes go awry. My thinking prior to the EU referendum vote on 23 June was broadly this: a stock market wobble in the weeks leading up to the event, but the vote would undoubtedly be Remain, and then we would return to the status quo. Well I got the first part right, at least.

So to a quick update on what has happened to investor sentiment since the UK’s historic vote to leave the EU… and how it has affected the stocks we own in the Old Mutual UK Alpha Fund.

Let the pound take the strain

Whatever your personal views on how Britain will fare outside the European Union, in the short term the currency markets have delivered their verdict. The pound has fallen 18% in value against the US dollar, from 1.50 prior to the vote to 1.22 at the time of writing. We are all poorer on the world’s stage, as anyone travelling overseas will discover – and as inflation is likely to rise in the coming months, as companies try to offset increased import costs through raising prices.

But for investors, it’s not all bad news – 75% or so of the profits of UK companies listed on the FTSE 100 index are earned overseas. When those profits are converted back into pounds, using the weaker sterling exchange rate, they are given an instant currency boost.

With around half of the fund’s holdings invested in very large companies, with substantial dollar exposure, there have already been meaningful upgrades to profit forecasts from the likes of mining company, Glencore, pharmaceutical companies, GlaxoSmithKline and AstraZeneca, and global banking giant, HSBC.

Courtesy of the falling pound, UK companies now carry cheaper price tags for would-be overseas buyers. Japanese SoftBank’s bid for British microchip designer, Arm Holdings in July, just weeks after the Brexit vote, may be the start of a string of British companies being snapped up by hungry bidders from abroad.

Time to change tack?

To my mind, the overall message from Brexit was a warning shot from Joe Public that not enough has been done, since the start of the financial crisis, to help those in the ‘real’ economy who are not rich in assets. Hence the reason why expectations are rising that Chancellor Philip Hammond will announce a more direct programme of fiscal measures, such as large-scale investment in infrastructure, in his Autumn Statement on 23 November. This has, in turn, led to the beginnings of a change in the type of stocks influencing the direction of the stock market. And here’s why…

The aforementioned infrastructure projects will need to be financed somehow. The most obvious way would be a massive sale of billions of pounds worth of UK government bonds, flooding the market, depressing bond prices and lifting yields in the process (let’s not forget bond prices move inversely to yields). Rising bond yields would be good news for a number of reasons, not least helping to restore much needed profitability to our unloved banking system through an improvement in banking margins. That’s good news for the fund’s holdings in Barclays, HSBC and Lloyds.

What’s next?

Apart from the ongoing negotiations of a ‘hard Brexit’, there’s plenty to occupy investors as we head into the home straight for 2016, not least the US Presidential elections on 8 November, the aforementioned Autumn Statement, and the Italian vote on constitutional reform barely days later. But fluctuations in share prices can often be a good buying opportunity for the long-term investor. The key is to keep on doing the company research, keep on doing the homework. As Warren Buffett once famously said, ‘risk comes from not knowing what you’re doing.’ Given the combined experience on the team equates to well over a hundred years or more, we hope we have at least learnt from some of our mistakes.

 

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