Doomsday Brexit predictions may have been overdone but its early days and caution prevails despite some cheer regarding US and Japanese equities.
- There is a lot of cash around, that's why market rallied
- Many UK share valuations still modest
- Caution on UK and Europe, cheer on US and Japan equities
Sterling crashed, government bond yields sank and stock markets around the world took fright in the immediate aftermath of Britain's EU referendum.
At first it seemed that Project Fear, the grim picture of Britain outside the EU painted by the Remain camp, had become an immediate reality. The overall feeling in markets was one of rudderless confusion.
As Rob Burdett of F&C Investments put it: 'We are where we are now. But I am not sure we know where we are.'
MOOD OF CAUTION
Fortunately, the plunge towards Armageddon did not last too long. Shares recovered and even the pound has gradually rallied slightly.
Alan Higgins of Coutts has a possible explanation for the rally: 'Ahead of the vote, the mood among fund managers had been cautious. There is still a lot of cash around and there has not been fuel in the motor to drive the market down. That is why the market rallied.'
That mood of caution was for the most part reflected in the scores of our panellists when last we canvassed them in May. Most of the scores were in or around 5 - indicating neutral or slightly underweight or overweight positions.
Average scores for all equity sectors ranged then from 5.2 to 6. Only Higgins himself took a more bullish stance, and hefiadmits this was not justified by events.
'Circumspection is the watchword while we wait for the fog to clear,' he says. 'The weather could hardly be foggier than it is now.'
Dunbar might be accused of sitting on the fence; but, he says: 'We think a balanced portfolio, not betting the farm on one idea, is the right approach. We need to let the fog clear a little before changing our stance.'
Schroders' Keith Wade describes Brexit as 'a leap in the dark'. And it prompts him to ask a broader question: is it just a UK problem or will it create a wider issue? Although he admits the UK on its own is not big enough to drag down the global economy, it could affect growth in Europe.
Connor Broadley's Chris Wyllie similarly stresses: 'We could see a domino effect. Britain is the second-largest economy in Europe, and if it were to go into a recession it would not be good for the rest of Europe, nor for global growth.'
Schroders has been warning about the dangers of Brexit for some time. In April it published an extensive analysis of the risks of voting to leave the EU. 'What we thought then is what we think now,' Wade says.
'We have always thought there would be a long period of limbo while a new trade deal was sorted out, and one of our biggest concerns was that hammering out this trade deal could take more than two years - maybe five or six years.'
That is an awful long time for businesses and investors to put things on ice. 'We believe inward investment and trade will be lost as a result of Brexit,' he adds. Like a number of other major City investment houses, Schroders has lowered its growth forecast for the UK for 2017 as a result.
'It is all quite concerning,' continues Wade, 'particularly as the political situation is one of considerable confusion.' However, Schroders' official stance on UK equities remains unchanged at neutral, with the score at 5.
UK equities are dominated by the FTSE 100 and by companies in international markets - oil, mining, pharmaceuticals and finance - and this factor, plus the recent weakness of sterling, makes all our panellists hesitate to go underweight in the sector.
'Our currency weakness favours UK equities, as valuations were already low,' says Wyllie. 'A lot of big investors are already underweight in the UK, and we are likely to see significant earnings upgrades in the coming months because of the currency effect on those earnings.'
But Dunbar disagrees. 'The political confusion in Britain could hardly be worse than it is,' he says. 'As the situation clarifies, sterling could well recover.'
Burdett reminds us how far the FTSE 100 has fallen since it hit a peak of 7100 in April 2015. 'Brexit does not help sentiment, but we have to bear in mind the modesty of many UK share valuations,' he says.
'We are mildly overweight in smaller and mid-cap companies because these are often very nimble players or global champions in niche markets. They could do very well out of sterling's fall.'
Higgins remains upbeat about UK equities and has decided to keep his score at 8 despite the gyrations of the market since Brexit. 'Translating revenues back into sterling for those big international companies that dominate the Footsie has left them looking attractive,' he claims.
There is much more caution among the panellists about European equities in the wake of the referendum. They also took a pounding at first. Burdett has lowered his score for this sector from 6 to 4, as he thinks Britain's decision to quit the EU 'may be worse for the Europeans than it is for us. We think it prudent to take some risk out of Europe at this time.'
Wyllie pegs his score for the sector at 4, while Wade does the same. In recognition to the uncertain times facing the EU, Higgins has cut his score from a bullish 8 to 7. 'It still pays to be in Europe,' Higgins says. 'Valuations are attractive, but there is no currency effect to boost earnings.'
JAPANESE SAFE HAVEN
Japan has emerged from this latest crisis with the strongest currency of all - riding higher even against the almighty US dollar. This has cemented its 'safe haven' status as a park for investors' money in such troubled times as these.
But a strong currency is not what Japanese premier Shinzo Abe wants to get his economy back on a growth track. This has led to a divergence of views over Japanese equities. Wade cuts his score from 5 to 4, while Burdett raises his from 6 to 7.
Wade says: 'In the current environment of risk aversion, investors see Japan as a safe haven. The resulting appreciation in the currency could well put a drag on the Japanese economy. Any fiscal boost won't happen until later this year, and any benefits from it will not come through for some time.'
In contrast, Burdett has raised his score because he believes equities there are undervalued and the currency now overvalued. 'Either the currency is the wrong price, or equities are wrongly valued. I think it is equities.
'Japan has just had some very good jobs figures and there is much evidence of company restructuring going on. Japan is not going to be derailed by anything going on in Europe.' Significantly, Higgins sticks with his score of 8 for the sector.
US equities have proved another safe haven like Japan: holding up well, with a strong dollar boosting the returns to sterling investors. None of the panellists is underweight here, now that Burdett has come into line - raising his score from 4 to 5. Wade remains the biggest enthusiast with a score of 7.
Wyllie points out: 'People are now anticipating lower interest rates in the US and there is no sign of America going into recession. For that reason alone I would not get too bearish on equities. There have been repeated crises in the eurozone but America seems to have carried on regardless. That is what has really created the valuation bubble there.'
EMERGING MARKET PROGRESS
With keen anticipation, our panellists see signs of progress in emerging market equities. For a start the bear market in commodities seems to be over, with the gold price surging and oil prices showing a big recovery from their lows.
The Thomson Reuters Commodities index is up from 156 in early February to 196 at the end of June, so key commodity producers such as Brazil should benefit. Burdett has raised his score from 6 to 7, while other panellists are staying neutral or slightly overweight.
There are intriguing differences in panel views on gold - the ultimate haven in times of trouble. With government bonds yielding next to nothing, the attractions of gold are highlighted.
Wade says he would give gold an individual score of 7, as Schroders is now overweight in the yellow metal. Wyllie thinks gold 'has just started its run and may go a lot higher'. In contrast, Higgins has been offloading the odd ingot into this rising market.
Lower than ever yields persuade our panel that government bonds are increasingly unattractive as long-term investments. 'We are very stale bears of government bonds,' Wyllie admits. 'But as building blocks for a long-term portfolio, they do not make much sense anyway.'
Despite a good upward run in prices since the dark days of mid-February, corporate bonds continue to attract attention, although Burdett has brought his score down from 6 to 5. 'The risk of defaults has increased as a result of Brexit,' he claims.
But for other panellists their appeal remains as a riskier proxy for government bonds, on their yield attractions. However, after progress over the past few months, Wade has lowered his score from 8 to 7.
Dunbar has one note of encouragement for investors generally. 'At least the Brexit crisis is not following the playlist the markets had in 2008. Markets are liquid and operating normally, and investors are able to discount the information put in front of them,' he comments.
COMMERCIAL PROPERTY: OUTLOOK OVERCAST
Shares in leading property outfits such as British Land and Land Securities took a hammering from the Brexit vote, on fears that the jobs outlook in the City will be severely damaged as banks move at least some of their operations to other capitals within the EU. There was even talk that Edinburgh might benefit from such an exodus.
Some of our panel have recognised the risks to the sector by lowering scores. Alan Higgins drops his rating from 8 to 7, Keith Wade from 6 to 5 and Rob Burdett from 5 to 3.
'There is now a bleak outlook for jobs in the Square Mile,' says Burdett. He points out that the managers of big property funds including Standard Life and Aviva have suspended trading in their flagship property funds. Elsewhere, Legal & General applied a fair value adjustment, which is currently 7.5 per cent, an improvement of 2.5 per cent over the past week. While, Aberdeen, which initially imposed a 17 per cent dilution levy on sales had at the start of August cut the levy to 1.25 per cent.
'Meanwhile, there is planning permission for 200 towers of 20 storeys or more for London,' he adds.
Richard Dunbar has lowered his score from 6 to 5. 'There is no need for panic,' he suggests. 'This is merely reflecting the uncertainty affecting all classes of assets in the wake of Brexit.
'Not all London commercial property consists of Canary Wharf type tower blocks: there are lots of sensible properties on sensible long-term leases to sensible long-term companies. In any case good properties yielding 4 per cent look cheap against government bonds. The hunt for yield will often end in bricks and mortar.'
There is caution too from Wade: 'Before Brexit, international players in the property world thought the UK was looking very attractive. They are now going to hold off until it is clear what the business arrangements are for the companies that intend to be occupying some of the properties up for sale.'
Chris Wyllie, however, thinks the negativity has been overdone. 'I think there is a danger of throwing the baby out with the bathwater; market valuations for some of the big Reits have gone to big discounts on asset values.
'Meanwhile, property companies operating outside London are offering discounts on net asset value and attractive yields of up to 5 per cent.' He raises his score from 6 to 7.
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