Rathbones' Smith: Shedding light on Brexit "unknowns" - Brexit decision tree
Rathbones today releases its “Brexit Decision Tree”. Rathbones’ head of asset allocation research, Ed Smith, believes that stopping at “we don’t know” is actually a missed opportunity. The decision tree shows a number of branches which lead to a range of possible outcomes. Those branches can then be adjusted to carry more weight as new information becomes available.
It turns out there is actually quite a lot of information in “we don’t know”. If that overarching conundrum is broken down into a sequence of smaller questions, Rathbones believes a much more helpful answer can be provided. A little extra knowledge might be important for investors, because financial markets are nothing if not probability-weighting mechanisms.
“We don’t know” does not equal “sell the UK”
Ed Smith says: “We assess the impact of each Brexit outcome on five key asset classes: sterling, UK-listed multinational companies, more domestically-focused UK companies, and both conventional and inflation-linked UK government bonds (‘gilts’ and ‘linkers’) see chart below. Brexit is not a globally systemic event and non-UK markets are unlikely to move in response. Only 3% of the revenues earned by US companies originate in the UK; just 6% for non-UK European companies. Even FTSE 350 firms make just 25-30% of their revenue in the UK.
“Our analysis suggests that sterling is already priced for a fairly hard Brexit. If Brexit were abandoned, we expect the pound would go up by more than it would fall should a hard Brexit be confirmed. On a long-run basis sterling is very undervalued. This holds even when we hypothesise an adverse Brexit scenario. Indeed against the euro, it is still undervalued almost by as much as it has ever been in the last 35 years (although the euro hasn’t existed for that long we can calculate a theoretical exchange rate based on the fixing rate at which the old national currencies joined the euro).
“A stronger exchange rate would normally weaken shares of multinational companies listed in the UK, holding all other things equal. Remember how the FTSE 100 outperformed immediately after the referendum and indeed for the rest of 2016, before underperforming dramatically for the next 12 months or so as foreign investors sold UK companies indiscriminately (regardless of their exposure to UK revenues)? But there is a good case for a softer Brexit resulting in both a stronger pound and a stronger FTSE. That’s because the FTSE is so under-owned by global investors.
“The latest BoA Merrill Lynch Fund Manager survey tells us that investors around the world are more or less the most underweight UK-listed equities they have been in the poll’s history. The national accounts tell us that net outflows from UK equities were larger after the referendum than at any time since 2007. If a hard Brexit starts to appear more likely, UK multinationals may be so under-owned, further selling could be limited and the exchange-rate effect should dominate.
“Weighting together the political probabilities suggests to us that, on balance, sterling is likely to appreciate and UK multinational companies should also do well. We believe that exposing portfolios to considerable currency risk by over-weighting overseas assets is perhaps not the best strategy given the current political outlook. “We don’t know” doesn’t lead us to “sell the UK”.
For further information, please see attached document. If you would like to discuss this with Ed Smith then please get in touch.
Intermediary PR (UK/Europe)
Rathbone Unit Trust Management
020 7399 0256
020 7466 5056