UK equities: Brexit nerves are not the only game in town
Stephen Macklow-Smith, strategist in the UK equity team, discusses what’s been happening on the UK stock market ahead of the EU referendum - and what investors can expect in the aftermath.
How has Brexit uncertainty affected the UK market?
Although the referendum is dominating headlines in the UK, it’s a mistake to interpret all market movements through this very narrow prism. Much more important so far in 2016 have been global factors. The year started with extreme pessimism about Chinese - and, by extension, global - growth and further weakness in commodity prices, before signs of a recovery in China drove a strong commodity price rebound. The biggest news on the UK stock market has been the resultant recovery in energy and mining stocks - a huge sector reversal that’s absolutely nothing to do with the referendum.
What about the currency?
This is where referendum nerves have had more of an effect, and it’s fed through into the market. Sterling has weakened, which means referendum uncertainty has actually been good news for many FTSE 100 companies, which source the vast majority of their earnings overseas. A cheaper currency makes UK goods more attractive to foreign buyers, and - more importantly in the short term - increases the value of overseas earnings. A company like BP, which prices its oil assets in dollars, gets an instant boost.
People have tended to misinterpret this, and see the underperformance of the more domestically focused FTSE 250 and FTSE Small Cap as evidence that there’s a risk-off trade happening because of the referendum. There is a little bit of domestic pressure, as we’ve seen in some of the economic news, but it’s much more about the rotation into globally-facing companies.
Do you expect a big market move when the outcome is announced?
The result is hard to predict, but the market is continually moving to reflect the probabilities, and will continue to do so until the vote. That means the aftermath might be much less volatile than many commentators expect.
It’s important to remember that a Leave win would only trigger the start of a negotiation, and the UK would retain full access to the European Single Market while that negotiation was taking place, so there would be very little immediate difference to our terms of trade. If sterling continued to weaken, it would mean further improvement in sterling-denominated corporate earnings - and also in dividends, which had looked under pressure. In the event of a Remain victory, we would expect an improvement in sentiment towards domestically tilted stocks.
Above all, we should keep in mind that the UK is a global market. What difference does it make to HSBC’s earnings if there’s an exit from the EU? We don’t know. But what’s far more important to HSBC - or to BHP Billiton or Royal Dutch Shell - is what’s going on in emerging markets - or in global commodity markets. These big global factors won’t change, regardless of the outcome of the vote.
How are you reflecting the uncertainty in portfolios?
As UK equity managers, we face five or six of these big, market-moving ballots a year, so this referendum is nothing new for us. For us, it never is and never should be about trying to call the outcome. Instead, it’s about sticking to our process and using our experience to manage and mitigate the risk.
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