Brexit: Impact on Investing
The results of yesterday’s EU referendum confirm that the British people have voted in favour of leaving the European Union commencing a Brexit. It is broadly expected that the UK government will act on the result in the near future and begin proceedings to start the two-year programme to withdraw from the bloc. However, this is uncharted territory, and the path to leaving may well be longer.
The uncertainty of this referendum vote has hung over markets for many years and particularly so in the last few months. There has been volatility in the equity, foreign exchange and fixed interest markets as investors have tried to predict the outcome. Unfortunately, although we now have clarity over the result, there is now uncertainty in the route the UK may take and what the trade relationships and economy may look like in the medium term. This may result in more depressed markets until negotiations are resolved.
The reaction to the result was broadly as expected. Notably, the pound sterling fell significantly reaching $1.32 against the dollar at one stage down from highs of over $1.50 within the last 24 hours. It is important to remember that the falls in all financial markets have come off the back of a very strong week to Thursday with many traders believing that the vote would be for remain. The currency is down only 3% over a two week period and has only just breached levels seen back in mid-February. For portfolios (viewed in sterling terms) a weaker currency will have a positive effect on most international equity holdings, particularly US dollar denominated investments.
Given the UK stock market is essentially a global stock market, with a large proportion of revenues earned in foreign currencies, with a Brexit weakening sterling will also benefit domestic stocks. However, the impact of this will not be seen immediately and may take time for markets to price in this advantage. If sterling remains around the current level for a prolonged period then companies with significant overseas revenues should see a boost in earnings growth. A weaker sterling may also make the UK an attractive candidate for foreign direct investment, although there might be lull in the shorter term.
There will continue to be significant currency volatility in the shorter term, and therefore, broad implications such as higher inflation will be difficult to predict at this early stage. Indeed many see a weaker currency as a benefit, improving international competitiveness and potentially reducing the current account deficit.
International equities have fallen on news of the outcome, which was also expected. This is likely to be more of a shorter term impact as the real implications of the result are likely to be more limited than those initially predicted. However, investors will now also be pricing in a possibility of wider disruption in the Eurozone as well as further political turmoil in the UK caused by this Brexit vote such as re-run of the Scottish referendum.
Gilt yields have also moved lower as the possibility of looser monetary policy from the Bank of England and indeed from the wider central bank community is priced in. The longer term trend for interest rates is also difficult to predict as it will be largely dependent on economic growth and inflation, both of which are unknowns in the medium term.