Having been cautious on markets all year, we went into the referendum with a defensive posture to our holdings with large weightings in healthcare as well as the recently built exposure to oil majors. This positioning was based on fundamentals and not because of any prescience about the outcome of the vote.
I expect Brexit to be nothing like as bad for the world as the sensationalist media likes to portray, although the truth is we are in uncharted waters and nobody knows. We have therefore made no strategic changes to the portfolios since the result. This is because, if anything, the uncertainty fostered by the Brexit result aligns the market more closely with our thinking.
It would be damaging for British and EU negotiators to rush a solution when participants are emotionally charged. Markets, however, despise uncertainty and confidence more generally may be shaken as events drag on, leading to investments postponed, jobs withdrawn and consumption deferred. Our biggest concern at this stage, therefore, is that the vote catalyses a European recession.
If there is a recession, it need not affect markets in a uniform fashion. We would expect larger cap* companies and non-cyclicals* to do better. Similarly, sectors where valuations have already suffered a bear market* are likely to be supported, such as the oil sector, where low oil prices are instilling capital discipline*. We began buying the oil sector in the third quarter of 2015 and with some shift towards these areas in recent weeks our portfolios have benefited.
It is telling that European markets suffered deeper falls in the initial panic than the UK market. A seemingly cruel irony of Brexit is that having retained its own currency, strain in the UK can be partially relieved through a weaker pound boosting exports and the translated overseas earnings* of UK companies. No such relief valve exists for individual members of the Eurozone and this ties into our second concern – that Brexit precipitates a return to crisis in the Eurozone periphery.
I am less inclined to worry about the UK and to be more concerned about Greece, Portugal and Italy. Challenged economies* means electorates in these countries are similarly disillusioned, with Italy confronting a referendum in October on political reform. Britain may not have the monopoly on political upsets. As for France, they are permanently disillusioned. Additionally, the banking sector in Europe, particularly in the periphery*, is in no fit state to deal with recession: capital buffers* in the sector are, in our view, insufficient. This has been the single biggest reason for our long-term caution towards banks.
Neither of these concerns need transpire. Central bankers may step in with additional stimulus measures*, although I would argue that fiscal stimulus* would be more useful given the stresses that negative interest rates and quantitative easing* (QE) are creating in the financial sector. QE is suffocating the lives out of banks.
It is hard to believe that Europe’s economy can escape unscathed. Despite the initial market correction*, equity valuations* are at levels that make sense only if further turmoil or recession can be averted. This leaves them vulnerable. In these fast-moving markets we will be tactical but no strategic changes are being made to our broadly cautious positioning.
Larger-cap companies: Larger businesses, in terms of their overall value. This is generally considered to be a company with a value of greater than €5 billion, although the definion does vary. In the UK, these are usually firms that are listed in the FTSE 100 Index.
Non-cyclical: Defensive businesses that operate in industries that are capable of performing well during periods of economic weakness, such as utilities (including electricity and gas providers).
Bear market: a period where share prices are falling, or are expected to fall.
Capital discipline: where a business is attempting to be more efficient, in terms of spending. Good capital discipline can be reflected in cost cutting, reducing debt or selling loss-making parts of the business.
Translated overseas earnings: where a change in exchange rates between currencies can affect profits for those companies that generate earnings from their overseas operations.
Challenged economies: Those countries with significant debts, high unemployment or other factors that are affecting their ability to grow.
Eurozone periphery: Those countries at the edge of the Eurozone, commonly seen as including Portugal, Greece and Spain.
Capital buffers: a mandatory level of cash that financial businesses are required to hold in order to provide some element of financial stability.
Stimulus measures: a series of economic measures used by governments or central banks in order to stimulate economic growth.
Fiscal stimulus: Where a government lowers taxes or increases spending in order to stimulate economic growth.
Quantitative easing: A type of monetary policy where a central bank creates new money to purchase government debt or other financial assets, with the aim of bolstering the economy.
Market correction: A stock market fall following a period during which stock markets have risen.
Equity valuations: Share prices.