In reality, the Brexit referendum result brings more questions than answers, writes Aidan Donnelly.
Well they’ve only gone and done it! As morning broke on Friday June 24th, so too did the reality of the news that the UK had voted to leave the European Union. Unsurprisingly, the market reaction was swift and brutal. The value of sterling plunged against most major currencies, in some cases reaching levels not seen since the mid-1980s.
When equity markets opened the initial response was equally savage but, as the morning progressed, investors became more discerning and a gap emerged between the ‘haves’ and the ‘have-nots’.
But the idea that the referendum outcome means the end of the issue could not be further from reality: the result brings more questions than answers. From an investor’s perspective the referendum result has implications in several spheres ranging from politics to economics, and, of course financial markets.
In some ways the political fallout from the result did not come as much of a surprise. David Cameron immediately announced his intention to step down as prime minister but cleverly delayed the date of departure until October to allow time for reflection and discussion by the key players.
As the days went by what became more apparent was that many in the exit camp never thought they would actually win the referendum, and therefore had no plan of action for life in a Brexit world.
What had been thought of as a protest vote –designed to give the government a bloody nose and justify some changes in the relationship with Europe – had succeeded in creating a void with no clear picture of what lay ahead. One after another we saw the ‘Out’ actors like Farage and Johnson exit stage left as the chorus of ‘what’s next?’ was met with deafening silence.
YES, PRIME MINISTER
Even the three-month hiatus period for a new prime minister didn’t last, as events worthy of a script in any episode of House of Cards culminated in the appointment of a successor to David Cameron. After a gap of nearly 16 years, we saw Britain confirm its second female prime minister with the appointment of Theresa May to Number 10. While the sudden move and the content of her official speech left many thinking that the post-Brexit policy agenda would soon be set, her new-look Cabinet raised more than one eyebrow!
Brexit does indeed mean Brexit and the long journey to exiting the EU is under way
The appointment of Brexit campaigners David Davis and Boris Johnson to secretary and foreign secretary positions respectively should remove any doubt that Brexit does indeed mean Brexit and the long journey to exiting the EU is under way. Although it will never be said publicly, there is the sense that Theresa May is saying: “Boys, you got us in this pickle, now you can sort it out. Here’s enough rope, so either corral everyone in or hang your own political careers – the choice is yours!”
Of course, these men will not be operating alone and the role of the new UK chancellor, Philip Hammond, and the Bank of England (BoE) governor, Mark Carney, will be crucial. The new chancellor has said that he wants to work closely with the BoE and others in preparing the autumn statement and a plan of action for the economy.
IT’S THE ECONOMY, STUPID!
One trend that has developed in the wake of the referendum result has been the rush to downgrade economic forecasts, not just for the UK but also for Europe and the world overall. Now it might just be the cynic in me, but I find it very interesting that forecasts for 2016 and 2017 are being reduced – and yet we still have no idea of when Article 50 will be triggered by the UK, what the outcome of the subsequent trade negotiations between the EU and UK will be, and to what extent they will impact upon the relative growth rates of various economies – not to mention what else could happen globally in the intervening period.
We have already seen some company managements point to the Brexit result as the reason why their profits so far this year are less than expected. But I guess that if it becomes the excuse du jour for every piece of bad news coming from the UK, at least it will make a change from the usual excuse of a wet summer – when in doubt, roll the Brexit out!
MR MARKET’S OPINION
Within days of the result, one asset market definitely in focus was UK commercial property, with the announcement by seven of the leading funds that they were suspending redemptions from their funds for six months. The move reminds us of the various ways in which Brexit can impact markets and make people fearful of more stress to come. Property is an illiquid asset, and this move shows what can happen to illiquid assets when the fundamentals/facts change.
In terms of size, various media articles have suggested that these seven funds cover more than £15bn of assets out of the total size of the retail UK commercial property market of around £25bn. Ultimately, the actions of these funds probably made sense given the nature of the asset, but it added to the unease of investors whose frayed nerves had them seeing danger lurk in every shadow.
DEVIL IS IN THE DETAIL
Looking at the stock market reaction could leave you scratching your head. Many people have asked me whether Brexit is such bad news for the UK, and why has the market done better than other areas since the referendum? The answer is down to the nature of the companies in the index.
When you look at an index like the FTSE 100, it is obvious that it bears no resemblance to the UK economy, given the large proportion of international companies in industries like energy, mining, pharmaceuticals, and food/beverages. With the majority of their sales going outside the UK, the significant weakness of sterling will mean a big boost to their profitability and a tailwind for their share prices – a silver lining to the grey cloud!
We are really only at the end of the beginning rather than the beginning of the end
That’s not to say there haven’t been some losers as well. The companies with greater exposure to the UK economy, like domestic banks, retailers, and construction companies, have seen price falls. Given their relative size difference in the index, the winners have outweighed the losers in recent weeks.
So although at an overall index level it might look as if little has happened, the devil is in the detail. A bit like a swan gliding across a pond: on the surface all looks calm, but underneath he is paddling like mad.
ARE WE THERE YET?
When it comes to Brexit, it’s fair to say that we are really only at the end of the beginning rather than the beginning of the end. Many decisions and much negotiation lie ahead for all parties involved and while this will create uncertainty for investors and volatility in markets, it won’t be the only headache to be dealt with.
The Italian constitutional referendum (October ‘16), the US presidential election (November ‘16), the risk of further terrorist attacks, and even general elections in Germany and France in 2017 are all potential banana skins for markets. Neil Sedaka had it right when he sang ‘Breaking up is hard to do’!
About the author: Aidan Donnelly is head of Equities at Davy Private Clients. Views expressed in this article reflect the personal views of the author and not necessarily those of Davy. Follow him on Twitter @aidandonnelly1. J&E Davy, trading as Davy, is regulated by the Central Bank of Ireland.