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25.07.2016

Giselle Roux: The long-term view on Brexit and global stocks

Since the financial crisis of 2008-09, there has been a sequence of events which have caused sharp reactions in investment markets. Brexit is the most recent, though at this stage the outcome has been relatively benign.

The chart shows the monthly percentage move of the MSCI All Country World Index over the 12 months after a big drawdown because of such an event, specifically the Greek debt blow-up in 2010, downgrade of the US's credit rating in 2011 and the most recent reaction to the slump in the oil price and a sharp rise in perceived risk from China.

This pattern suggests if you do not sell very early in a dislocation, you are better off waiting before you make a decision. It also disproves that buying into a pullback is always a good idea. The 12-month returns after Greece's bailout were good, but those after the US downgrade and the recent slump have been uninspiring.

That is not to dismiss Brexit's relevance. Rather, there should be a reassessment of the outlook to determine changes to a portfolio.

Brexit fallout

Issues most commonly raised now by global equity managers include:

Whether the fall in sterling will compensate for the risk of Britain entering recession. Given that 72 per cent of FTSE revenue comes from outside Britain, the domestic economy does not necessarily determine corporate profits.

Bank stocks and financials bear the brunt of instability. Index funds exacerbate those moves. Yet balance sheet quality has changed dramatically and if all banks are painted with the same brush, it opens up options.

Pricing in political uncertainty is impossible to quantify. Watching business and consumer confidence across Europe in coming months is critical. On the other hand, monetary support and possible fiscal stimulus could be buffers. There are few equities in global fund portfolios that ride off the notion of strong European economic growth. Instead, funds like the big multinational healthcare, consumer staples, car and travel companies that happen to be domiciled in Europe.

Defensive companies (consumer staples, healthcare, yield stocks) are likely to maintain support but their valuations are increasingly unattractive. The measurable outperformance of this theme is becoming more selective.

Value v Growth

The US and European markets are expensive compared with their historic average, while Japanese and many emerging markets are trading well below past valuations. Mean reversion is not a short‑term game but the patient investor is usually rewarded by paying attention to these cycles.

Value stocks have done better than growth stocks this calendar year, most evident in sectors such as healthcare. Development of the value to growth style may see some underperforming managers regain kudos.

But few can ignore that the earnings growth for most regions and sectors has been waning and Brexit won't help. Asset allocation is stuck in a tight spot. Fixed income is relatively stable, but low return. Bonds have been the star this year, yet it would be a brave investor to buy into bonds now for medium-term potential.

Equities are not cheap and the lack of earnings growth is unhelpful. Funds might talk the mantra of stock selection and picking companies that can withstand tough times but markets tend to move in unison and high sector correlations belie the idea one can be corralled from the general trend.

The natural inclination of investment advisers is to recommend "staying in for the long haul". In some cases that makes sense, on the assumption the portfolio is indeed designed to be around for some time.

But adjusting weightings to adapt to conditions does not mean a change in time frame. Those who do reduce their global equity component should do the same with domestic equities and be prepared to step up again when advised.

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