Britain faces uncertainty, but the FTSE is a global market

They say a week is a long time in politics.
After the past few days, we’re going to need a bigger scale.
A week has proven to be a long time in the turbulent markets, too.
True, the British pound fell on confirmation of the public’s vote to leave and stayed down, but shares have been all over the place.
Indeed large-cap UK shares rallied after initially plummeting on the news, as I predicted they would when I wrote to you the morning after the vote.
The weak pound boosts their international earnings. Those comprise the majority of the FTSE 100’s revenues, so it’s logical their share prices would rise.
Domestically focused UK stocks have continued to suffer, however.
Investors seem to have decided that the shares of homebuilders, for example, are underpinned not by solid foundations but by quicksand.

Things can only get better, the same, or worse

I don’t expect this divergence between companies that rely on the UK economy for their wellbeing and those who make the majority of their money overseas to end any time soon.

The risks surrounding Brexit seem enormous, but they are currently restricted mainly to the UK – at least in terms of the economic impact.
One way to improve the UK outlook would be for politicians to unite behind a vision of how we plan to resolve our fractured relationship with the European Union.
But with senior political figures having been ‘decapitated’ or disempowered left and right, any such clarity looks months away.

Multiple options, many ramifications

How the UK is positioned in the post-Brexit world will ultimately be the most important thing for the British economy and the businesses we invest in.
There are several competing views as to how we should proceed, and for now we can only speculate about their likelihood or impact.
Over-simplifying, the main options seem to be:
No Brexit – Millions of people have indicated via a petition that MPs should either ignore the referendum or hold a second one. In this scenario, we’d presumably move back to business as usual, albeit at the cost of political resentment and a now inevitable economic speed bump. Few politicians seem to be countenancing ignoring the vote, however.
Norway option – Modelled on Norway’s arrangements, the most widely mooted solution keeps us in the single market by joining the European Economic Area (EEA) and maintains freedom of movement of people. For most businesses this is probably the best Brexit option as it is closest to the status quo, with the benefit that we could sign new trade deals with non-EU entities. However, there will be some costs involved, including tariffs and UK payments to access the market, and the UK would have to simply accept EU regulations on goods it exports. Also, many people clearly voted Leave to curtail freedom of movement. So this may not be a goer.
Swiss option – A further step away from today’s arrangements with greater scope for the UK government to dictate certain contentious domestic laws, Switzerland operates in the European Free Trade Area (EFTA), which affords its manufacturers similar access to the EU as ours have today. Again there are costs, regulations we’d have to take but not influence, and no changes to freedom of movement. Critically, access for service companies – such as our key financial sector – would also be more restricted. Any blow to the City wouldn’t just hit UK financial stocks, but also commercial property, recruitment firms – indeed, perhaps any business geared to the health of the UK economy, given the size of our financial sector.
WTO membership – Unless they can strike a concession on freedom of movement (which Europe says is not possible), UK politicians could feel compelled to leave the single market. Instead, we could trade with the EU as a member of the World Trade Organisation (WTO), like the US or China. This option has different impacts on different sectors, as tariffs applied to WTO members vary greatly. For example, tariffs on agricultural goods seem prohibitively high. The hope would be we’d find new markets for our goods to make up for any loss of exports to the EU, but this would take time. Again, financial services’ access to the EU would be constrained, causing some short-term economic and market impact at the very least.
Canada option – Canada is working up a special trading relationship with the EU. To my inexpert eyes, there still seems to be plenty of downsides in terms of some higher costs applied in order for goods to enter the EU and again the inability of the UK’s financial firms to maintain ready access to the EU’s hundreds of millions of customers. The upside is the most control and a potentially tailor-made trade deal. Keep in mind a bespoke deal would take years to negotiate, meaning a long period of uncertainty. Even Canada’s deal is not yet ratified!
It seems clear that Brexit likely means headaches for businesses, potentially higher costs, and in the worst-case, a serious hit for financial firms if their access to Europe is restricted.
On the other hand, a Brexiteer might retort that not only can we forge a new and superior relationship with the EU on account of our existing trade with the continent, we will also be able to compensate for any downside by boosting sales to non-EU markets, particularly fast-growing ones like China and India.
Such advances might give UK public companies that already have a toehold in these markets an early start to winning that race.
What’s more, on the domestic front the UK might strive to make itself even more attractive for businesses, which could offset also some pain.
George Osborne has already floated the idea of a cut in corporation tax to 15%, for instance, as one way to disperse the gathering clouds.

Keep your eyes on the bigger picture

There’s no denying that the decision to leave the European Union has shaken our political system, and that it will likely have an economic impact of some sort, too.
Only time will tell exactly where we end up. Even our best thinkers have been flummoxed on the ramifications of Brexit – and I am not one of our best thinkers!
From an investing point of view though, it’s important to think about where your companies actually do business, and how much any slowdown in the UK economy will really affect them.
For many – perhaps a majority – of UK multinationals, the impact to their operations and earnings could be minimal.
Any slowdown in the UK economy could be compensated for by stronger overseas earnings from the weaker pound, or by their goods and services becoming more competitive on the global stage for the same reason.
Even for British focussed companies, you want to take time to pick between the winners and the losers.
Some companies – particularly growth stocks that aren’t tied to cyclical areas of the economy – have grown through past downturns in the UK economy, and the same will surely be true again.
Investing will always throw us some curveballs, and Brexit is no different from that point of view.
Thinking long-term and knowing your companies as real businesses not as share price tickers can help you to keep your footing in the most unsteady of times.

Remain focused on the long term

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