Investment Environment - The Aftermath of Brexit

27.07.16

The events of BREXIT certainly caught the financial world off-guard, probably more so than any other such event with the general expectation of a “no” being signalled by both equity markets and Sterling strength on Thursday 23 June. Now that the BREXIT vote is 4 weeks old and the UK political shenanigans have run their course, it would appear that equity markets have resumed their trend. The FTSE (UK equity index) has resumed its upward trend with a downward blip caused by BREXIT as shown below. However, Sterling has been the casualty and has devalued from USD 1.48 / GBP to the current level of 1.32 which has effectively discounted the UK by 11%  - ie UK assets are cheaper to this extent.

More importantly, the graph above of the S&P500 (USD equity index) has broken out of its period of consolidation albeit only marginally and is signalling further strength from here on. While the FED probably stuttered on interest rate increases around BREXIT, it would seem that the focus is now on the stronger than expected US economy and forecasts are that interest rates are going up towards the year end.

It will be interesting to see how markets react to an interest rate increase in the US (expected in September) as higher interest rates are generally not good for equity markets and could cause a risk-off approach. However, we believe that in fact the contrary might be true and that the increase in interest rates will be regarded as a signal of a normalisation of the US economy, and that due to the fact that interest rates remain benign albeit increasing, that the risk-on approach is maintained. This scenario will have a higher probability if we continue to receive strong economic indicators out of the US, combined with the indicated stabilisation of the Chinese economy. The stabilisation of China will make it less of a drag on world economics.

What happens to the UK and the EU post BREXIT is anyone’s guess, because while the decision has been made, but the deal is yet to be agreed! As a result there are arguments either way on both sides of the Channel. Our conclusion remains to stay predominantly with US multi-national equities that will ply their trade in the most appropriate markets. There is no doubt that the US economy is leading the world recovery.

With respect to the JSE the market continues to perform reasonably but remains in a period of consolidation as shown in the graph below. 

A break-out, as has occurred in the US, could be catalysed by better commodity prices and/or a weaker ZAR which is currently surprisingly strong and could be a casualty of either the upcoming municipal election surprises (strife, changes in power etc) or the thundercloud of a credit downgrade at the year end. As a result we continue to take our long standing position of encouraging clients to invest abroad using their foreign investment allowance or trackers, or focus on SA equities that have strong offshore businesses. 

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