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Don’t be misled by the FTSE 250’s post-Brexit mini-revival

In the two trading days following Brexit, the FTSE 250 slumped by over 13% as investors became nervous regarding the prospects for the UK economy. The FTSE 250 bore the brunt of investors’ fears because it is much more dependent upon the UK economy than the FTSE 100. However, since Monday, the FTSE 250 has staged a revival of sorts. It has risen by over 5%, but investors shouldn’t get too excited just yet.

Considerable volatility

A key reason for this is that the effects of Brexit will take years to fully transpire. We are less than four working days in to a new era for the UK economy and it will therefore take time for the full effects of the decision to be made clear. Therefore, there is likely to be considerable volatility in the next few years, and it could be easy for investors to mistake  a couple of days of share price gains for the start of a bull market. However, the reality is that such an uncertain future generally means that price movement is the result of  volatility rather than a sustained trend in either direction.

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As mentioned, the FTSE 250’s constituents are highly reliant upon the UK economy for their earnings and this could cause a number of problems for the index. While the FTSE 100 is set to benefit from rising earnings as sterling weakens and the global economy continues to offer upbeat growth prospects, the UK may experience a recession and this would undoubtedly cause the FTSE 250 to fall.

Reduced foreign investment

Of course, there is no certainty of a recession, and the UK economy will gain a boost from a weaker currency. That’s because exports will become more competitive and their contribution to GDP will rise. However, imports will simultaneously become more expensive, and this could hold back consumer spending at a time when people across the UK are already feeling nervous about their jobs and financial future.

Furthermore, the UK’s exit from the EU could cause reduced investment from foreign companies. Access to the single market is favoured by multinationals and if the UK does not gain access, the job losses or job relocations could become a feature of the next few years. This would have a detrimental effect on the FTSE 250 since, as a UK-focused index, it is much more closely tied to the macroeconomic outlook for the UK than is the case for the FTSE 100.

Higher potential rewards

Despite this, in the long run the FTSE 250 is likely to prove to be an excellent investment. This may sound counter-intuitive at a time when its outlook is exceptionally uncertain. However, the UK has faced numerous challenges in its history and has always been able to recover in the long run. As the sixth biggest economy in the world, there is still significant appeal for companies and individuals to invest here. That’s even more so when the UK’s talent pool, political stability and ownership rights are factored in.

And of course, with the FTSE 250 having fallen since Thursday’s vote, it now offers even better value for money and higher potential rewards. So, for long-term investors, buying now seems to be a sound move. But they shouldn’t think that the worst is over after just a day and a half of gains.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.