After significant political fallout and numerous high profile resignations on both sides of the House, we now know that the next Prime Minister will be one of two people. Theresa May, who was broadly in favour of Remain, is currently most likely to win over Andrea Leadsom who is firmly in the Brexit camp. However, more than ever, recent events have led us not to trust the polls or the bookies…

It doesn’t help that there will now be a significant delay before knowing exactly who the next Prime Minister will be. The 150,000 Conservative party members will decide via postal vote, and so we will not know the true ambitions of the ‘new’ UK government until 9th September.

The economic effects of the vote

The future of the UK’s relationship with Europe is still unknown, and there are several hurdles to get over before Article 50 can be invoked. Yet the implications of Brexit have already been felt politically and economically around the world.

In the UK, the most obvious impact of the Brexit vote has been the fall in sterling, but ripple effects have been felt in Europe and across the globe.

In broad terms, the prices of bonds and gold have risen as capital has sought safe havens. This rise in bond prices of course means a fall in bonds yields, and interest rates may well also fall in the UK, which will further reduce the prospect of any return on cash. The search for yield is likely to provide support for those equities which are still offering dividends in excess of 3%, such as healthcare companies, telecoms and utilities.

As mentioned in our previous note, our equity investments are focused on companies which are multi-national, and therefore much less dependent on growth in the UK. It is no surprise that since 24th June the FTSE 100, which contains companies that are global in nature, has significantly outperformed the FTSE 250, which contains companies more dependent on UK growth.

Certain sectors have experienced acute pressure, such as the UK banks and UK commercial property. Neither, I hasten to add, feature in any significance in our investment strategies.

UK banks

UK banks have been severely impacted by Brexit with RBS losing a third of its share price and Lloyds losing a quarter. Exposure to commercial and residential property loans, combined with a probable slowdown in new lending, will harm profitability just at a time when the banks were poised to recover from the financial crisis. The potential reduction in interest rates will also harm their ability to generate profit via the difference between borrowing and lending rates.

UK commercial property

The referendum result has naturally caused concern about the impact on UK commercial property. Hence many investors in property funds have been keen to sell their investments. However, in the case of direct property funds, it takes time to sell the underlying properties. In investment jargon, this means there is a mismatch between the ‘liquidity of the underlying and the liquidity of fund structure’. Essentially, problems arise when investors wish to withdraw their cash faster than the property manager can sell the underlying asset.

The rush for the exit has led several high profile asset managers to ‘gate’ their property investment funds, which means investors are unable to withdraw their cash. Aberdeen, Threadneedle, Legal & General, Aviva, Standard Life, M&G, Henderson, and Canada Life have all gated their funds. In some ways, the gating protects investors from themselves. If the manager was required to sell the underlying assets in order to meet demands for withdrawals, this would amount to a fire sale, and the result would be self-fulfilling, guaranteeing a downward spiral of prices. If more confidence returned to the UK market, assets could be sold in an orderly fashion and stability could be restored.

One knock on effect will be the impact on the share prices of those asset managers who manage significant property funds, although clearly property alone should not be a material impact on their businesses.

A long summer

Uncertainty will remain high over the summer which means a great deal of business activity in the UK will remain on hold. This is likely to mean slower growth and probably a technical recession (two quarters of negative growth) even if the contraction turns out to be short-lived.

It is unfortunate that we must all now wait until 9th September before knowing the Conservative government’s plans. However, whoever the new Prime Minister is, there will be pressure on the government to promote stability and reduce uncertainty. This primarily means securing an optimum trading position with regard to Europe and the rest of the world, and using fiscal policy (to include tax cuts) to boost growth and promote the UK as a place to do business. It is also in the EU’s interests to seek a workable outcome with the UK. Hence, despite the initial negative rhetoric from various high profile individuals, we expect the key power brokers in Europe will ultimately encourage and work towards a sensible resolution.

Lastly, central bankers around the world will wish to do their bit to promote stability in the global financial system via monetary policy. Mark Carney, governor of the Bank of England said on Wednesday “The Bank can be expected to take whatever action is needed to promote monetary and financial stability, and as a consequence, support the real economy”. This may well mean a cut in UK interest rates in the next few months. In the US, the progression of interest rate rises is likely to be slower than expected prior to the referendum, and in Europe, the ECB is likely to continue to accelerate its supportive asset purchase programme.

Conclusion

The uncertainty highlighted above leads us to be relatively cautious over the summer. However, the whole world is now watching and it is in the interest of the global economy to achieve resolution and restore stability. In the UK we expect the government to focus on fiscal support, and the Bank of England is committed to providing liquidity as needed.

In terms of portfolios, we are confident that our strategies are well placed to weather any further surprises in the coming months.

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