Brexit & the Markets:UK & Fixed Interest

July 5, 2016

UK Equities

UK equities have uncertainty now hanging over them. However, the potential medium to longer term impact of a Brexit are likely to be low. Trading in the interim is likely to be polarised between different sectors of the market, and will continue to be volatile. Larger cap companies will benefit greatly from a weaker sterling and this will likely provide support for the market.

The volatility and divergence of the market may well provide a good hunting ground for active managers in both the larger and smaller cap companies’ spaces.

UK Sterling Volatility

The currency weakness and its effects on companies’ earnings is likely to be underappreciated in the shorter term. Therefore, it is unlikely to be beneficial to make  switches into international equities quickly. Valuations following the referendum volatility remain broadly attractive meaning that there is not a significant concern over high price levels.

There is clearly a higher risk in UK equities at the current time. If there is indeed a slowdown in economic growth in the UK (and Europe) then company profits may be compressed, however, the valuations at the current time reflect some of this risk.

Fixed Interest

Underlying Gilt yields have fallen sharply on the result of the referendum. An increased probability of further quantitative easing or an interest rate cut by the Bank of England and depressed yields along the curve. Given deflation is now even more unlikely under a weakening currency, the rate of return available is not attractive given the risks/costs. Rising inflation may cause a weakening gilts. Only time will tell whether economic growth or inflation will be the main driver of BOE policy decisions.

Credit risks in sterling corporate bonds has widened slightly although this was expected on a leave result. The move has not been overly significant. Furthermore, the spread came in significantly in the run up to the referendum, making the net move marginal. Sterling corporate bonds allow the potential to generate a higher rate of return as well as benefitting from the QE programme being undertaken by the ECB where they have just begun to purchase corporate bonds. There will undoubtedly be an indirect effect from this. Likewise, high yield bond spreads have also widened.

You should always remember that the value of your investments and any income from them can go down as well as up and you may get back less than the amount you originally invested. All investments carry an element of risk which may vary significantly. If you are unsure as to the suitability of a particular investment or product, you should seek professional independent financial advice.