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Investments – the Brexit Bounce

Written By: Mark Cooper on August 15, 2016 No Comment

Investment MarketsThe historic decision on 23rd June 2016 by the British public to leave the EU was a largely unexpected outcome that caused immediate havoc in global financial markets, notably UK and other stockmarkets and currency exchanges.

I wrote to all clients the day after in order to reassure, keep their eye on the longer-term and, in short, suggest they do nothing and let matters sort themselves out for now – sound advice as things soon turned out.

After the initial wobbles the stockmarkets, both in the UK and globally have soared, to the extent that the US S&P500 market, by far the largest in the world, has gone on to reach new all-time highs, with the FTSE not far behind. What exactly has been going on?

First things first, the pound remains below the pre-Brexit level against other currencies and this does have an impact on frequent travellers and those planning a major purchase abroad, such as buying a property. That said, the biggest challenge facing the UK economy both pre and post Brexit, is a large imbalance between total imports v exports and a weaker currency will undoubtedly encourage exporters and attract further foreign investment in the UK, a boon for the longer term. Had the Bank of England wanted to defend the pound they could have done, but our balance of payments deficit is clearly on their minds too.

Turning to Shares and Bonds, their dramatic increase of the last two months, it comes largely down to one word: Yield.

Globally there is an ever growing demand and need for an investment yield with the sources of sufficient reliable income dimishing all the time. Central Banks around the world have been crushing the yield on Sovereign Debt (loans to Governments) since 2008, to the extent that 30% of global Sovereign Debt now has no yield whatsoever, or even offers a negative return. In sympathy Corporate Bonds (loans to companies) have seen yields falling to record lows, their price going up as a result. Initially such “asset purchases” or Quantative Easing (QE) by Central Banks were designed to artificially lower interest rates and the burden of servicing colossal national debt around the world. Arguably these low yields now reflect a sluggish global economy and scarcity of inflation in all but the most damaged economies of some South American and African nations.

Shares produce a yield, but not a guaranteed one, through payment of dividends, a share of the company’s profits when applicable. Many large companies, including those who produce essentials such as food and drink, healthcare, communications and IT, energy and, alas, cigarettes and military hardware, offer dividends considerably higher than the yield on their own Corporate Bonds. For income seekers Equities (Shares) have become the “cleanest dirty shirt” with buyers willing to pay more for a reliable but not guaranteed source of income. Yields go down so share prices go up – provided the dividends look likely to keep on coming.

In the light of the Brexit shock Central Banks around the world have softened their stance and changed their austerity rhetoric, with UK interest rates reduced and likely to stay lower for longer, or even fall further. The fresh stimulus of further QE will find its way into asset prices via the global financial system. This pushes Bond yields down once more with good quality Share and Bond prices rising further in value as a result.

The “Brexit bounce” has produced a very welcome filip for investors who have felt mired in a moribund period of two steps forward, two steps back in recent years. It doesn’t necessarily signal a return to the good times yet and such progress could prove to be a one-off re-rating for now, rather than the start of a sustained resurgence, but nonetheless it does remind us that over the long term taking a measured and appropriate level of risk should bring rewards over and above those available from cash deposits – that is still the foundation stone of capitalism.

Next, the US elections in November will become the focus and who would dare predict the outcome of that particular contest? Whatever it might be, markets take it in, they adapt if necessary and the world keeps turning – so keep the faith.