What should you do as Brexit triggers sharpest economic contraction in 7 years?

Prior to the EU referendum, people who really should know about economics (including the Chancellor of the Exchequer and the Governor of the Bank of England) predicted a downturn should we choose to leave.

Early signs suggest they were right, after IHS Markit’s Purchasing Managers Index fell to 47.7 in July, indicating the UK economy’s steepest pace of contraction since 2009. The survey found that both manufacturing and service industries were hit, as output and new orders fell at a record rate.

The fall in manufacturing output and orders is the first since Q1 2013. And though exports enjoyed a boost thanks to the falling pound, the downside is that manufacturers’ import costs have risen sharply.

Post Brexit recession?

Markit’s chief economist Chris Williamson said the fall “was most commonly attributed in one way or another to Brexit,” and that the result suggests a 0.4% economic contraction in Q3, depending on whether we see further deterioration. He added that the “record slump in service sector business expectations” suggests there’s more to come.

What should we do?

Obviously, don’t follow the sheep in the City and sell off everything in sight. No, we should re-evaluate our shares with a long-term view. And in the shorter term, we should be chasing exactly the same strategy as smart investors were doing during the banking crisis and seeking oversold shares to buy.

Which are the bargains?

We should first examine the sectors that have been hit hardest. For example, even if some financial firms may genuinely suffer from Brexit hardship, the market will typically punish the whole sector — even companies that shouldn’t face any problems.

The most obvious one to me is insurer Aviva, which was very quick to respond to the referendum, proclaiming that the result “will have no significant operational impact on the company.” Yet the shares are down 15% since the day and are now on a P/E of only 8.3 with forecast dividend yields of 6%. Tasty.

The other obvious big fallers are the housebuilders, with Barratt Developments down 30%, Taylor Wimpey down 25% and Persimmon down 24%. On P/E ratios of only a little over half the FTSE 100 average and with attractive dividend yields, do they sound cheap? They do to me.

Seek safety

Another approach is to look for shares that shouldn’t be affected whether we’re in the EU or out (though, arguably, that’s something to have done before the vote and before their prices rose).

GlaxoSmithKline, which released results on Wednesday, has already committed to further investment in the UK — and though the shares have gained 17% since the vote, I reckon they’re still good long-term value.

Then you could look at what the top experts have been doing with their investment cash. Neil Woodford has spotted the insurance sector bargains and has snapped up some Legal & General shares, and has also bought into sub-prime lender Provident Financial. He’s also invested in outsourcers Babcock International and Capita Group, both of which have said they expect little overall Brexit damage.

The bottom line is that we shouldn’t see this as a disaster. We should do the opposite and see it as an opportunity to boldly profit from the fears of others, and turn the lemon we’ve been handed into lemonade.

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Alan Oscroft owns shares of Aviva. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.