Speaking this morning at the Pro-Manchester Brexit Debate, John Goodall, Head of Private Client Research discusses how markets have performed ahead of the EU referendum.
Looking at currency markets, the pound performed poorly at the start of this year against the US dollar, hitting a level of $1.39 in late February, the lowest since 2001 and down from a peak of $1.72 in July 2014. It has recovered since February and is slightly down for the year to date, about 4% at around $1.41. Against the euro, it has also weakened this year slightly more, by around 7.5%. €1.24 in April was the lowest level seen in around two years. It is currently around €1.26 but we have been much lower.
The Bank of England claim that around half of the weakness in the pound is due to Brexit fears. I am not so sure about this.
The most important long-term factor behind currency movement is people’s assessment of the economy’s health and long-term prospects, particularly with regard to interest rate expectations. With the US raising rates last December and the Fed signalling there is more to come, US interest rate expectations in relation to the rest of the world are starting to diverge, although there are some question marks about the timing of a rate rise following recent disappointing US employment data. And in a low interest rate environment, this small difference counts for a lot, explaining why the US dollar has been in demand. With the US economy showing relative stability, and the UK still struggling in many respects, the record current account deficit, a stubborn budget deficit and an economy still heavily reliant on the financial and property sectors, Brexit appears like a convenient excuse in the face of these factors.
Bond Markets have been fairly stable, reflecting lower long-term interest rate prospects.
UK ten year gilt yield has dropped from 2% at the start of the year to 1.1%, now record lows. This follows a wider trend of lower rates, even US rates have fallen from 2.1% to below 1.6%. German 10 year bunds yesterday fell below zero for the first time.
It has been a volatile year in general for equity markets. The UK markets fell 11% to 5,536 in February before rallying back to recover all its lost ground. John said “I would suggest that Brexit is not the only issue here, we have concerns over China’s growth, worries over US interest rate rises to name but two. Lots of firms have been keen to use the Brexit excuse. And in some cases this may be valid.” Some IPO activity has been delayed due to the uncertainty and some investment decisions will have been delayed.
When looking at the UK equity market, the best performers this year to date have been Basic Resources and Oil & Gas. The worst Banks, Real Estate, Financial Services, Travel & Leisure.
It is difficult to say with certainty that any of these are solely down to Brexit. Basic Resources and Oil & Gas have performed well – largely due to a recovery in commodities. This is partly down to speculation that the oil market will rebalance soon.
On the downside, Banks’ underperformance could be partly to do with Brexit. But more likely due to the scaling back of UK interest rate expectations, which will mean margins will stay low, and the ongoing cost of regulatory burden. Travel & Leisure has been partly hit by concerns over terrorism affecting flights in certain areas, mainly north Africa. Real Estate valuations had got out of hand after a strong run, with shares trading at substantial premiums to NAV.
Residential property has been hit by changes to stamp duty and also tax changes which will make it harder for buy-to-let landlords to make money at a time when valuations are looking increasingly detached from underlying earnings.
Commercial property has been hit by falling demand from overseas investors, who have recently accounted for around half the demand. In part this may be due to the declining funds coming from the Middle East, Russia (lower oil prices and economic sanctions) and China (with the slowdown there).
John said “I find it hard to believe that the majority of these changes are solely Brexit related. There are clearly other global factors at play too. And that is the point with around 70-80% of UK top 100 companies revenues actually derived from overseas. The proportion falls as one goes down the market cap, UK top 250 shares is around 50% UK/overseas revenue and lower down, smaller companies will on balance be more exposed to UK revenues.”