News coverage at present is focused on Donald Trump. That’s understandable. After all, he’s just over a week into his presidency and has already made several changes, such as exiting TPP negotiations and promising/threatening to renegotiate NAFTA. However, over the next nine weeks, the attention of investors and potentially the world’s media is likely to shift towards Brexit. That’s because in nine weeks or less, the UK will have formally handed in its two-year notice to leave the EU.
Uncertainty
Clearly, investors are well aware that the UK plans to invoke Article 50 of the Lisbon Treaty by 31 March at the latest. Furthermore, markets know the UK will leave the EU within two years of that date. However, it’s unlikely that the uncertainty the two year negotiation process will bring has been adequately factored into valuations. That’s especially obvious since the FTSE 100 is still within 5% of its record high. As such, it seems to price-in major success, rather than failure.
Of course, Brexit doesn’t necessarily mean the UK economy will be worse off in the long run. It could become a more nimble economy which is better suited towards fast-paced globalisation. However, while negotiations are ongoing, it seems likely that uncertainty will be high. The end result from the talks is an unknown and judging by statements made from both sides, neither is going to compromise on certain issues, such as immigration.
Therefore, it seems likely that investors will become more cautious regarding the UK’s economic prospects over the next couple of years. Since this period is due to start at some point within the next nine weeks, it could prove to be the start of a crucial period for the FTSE 100.
Investor response
While some investors may feel now is a bad time to buy shares, quite the opposite could be true. In the weeks until late March, the market may begin to price-in the greater uncertainty which is set to be present over the next couple of years. This could lead to a number of high quality companies trading on lower valuations as a wider margin of safety is sought by investors. As such, now could be a good time to raise cash, await even more appealing valuations and buy for the long term.
One area that may be worth focusing on is FTSE 100 stocks that report in sterling, but operate mostly abroad. They could benefit the most from greater uncertainty because it may cause the pound to depreciate. This would boost their earnings to some degree and it could have the same effect on their share prices. Similarly, companies with high dividend yields may also become more popular if inflation rises to the expected 3% or even 4% in 2017.
Clearly, volatility could make the next couple of months a challenging time to be an investor, but it could also be the start of a period of great opportunity for long-term investors.
