So, the results are in and the UK has decided to leave the EU. For some this will bring joy, for others despair. However, in terms of investing it’s likely to create major differences between the performances of different sectors within the UK stock market.
Clearly, the outlook for the UK economy is now much more uncertain than it was just a handful of hours ago, so companies that are focused on the UK for a large part of their sales and profitability have been hit hard. Similarly, companies that operate mainly outside of the UK haven’t been hit anywhere near as hard, with some stocks that operate exclusively outside of the UK and EU not posting significant share price falls.
Drilling down further into different sectors, it’s clear that defensive industries are likely to perform well both in the short run and the long term. In the short run, there appears to be a flight to safety, with tobacco companies and healthcare stocks seeing minor share price falls (and in some cases share price rises) as investors seek out companies that are likely to prove resilient in the face of significant uncertainty.
And in the long run those same sectors are likely to perform relatively well too, since even if Brexit sparks a global recession, tobacco and healthcare companies are likely to record strong sales and profit growth. That’s because their performances as businesses are less positively correlated to the performance of the wider economy than is the case for the vast majority of the UK stock market.
Questions, questions
In terms of the sectors that are set to be hardest hit by Brexit, cyclical industries are likely to be hurt today and also in the long run. For example, retailers and sellers of consumer discretionary items should be among the hardest hit companies because sterling has already begun to plummet and this could cause inflation to rise due to imports being more expensive. In turn, interest rate rises may be required to curb higher inflation. But with a weaker currency also making UK exporters more competitive and thereby giving a boost to the UK economy, in that sense, the requirement for lower interest rates may be somewhat reduced.
This increase in interest rates would clearly hurt consumer confidence and therefore is likely to cause retail and consumer discretionary shares to fall. Similarly, a fast-rising interest rate could cause defaults on debts to rise and mean that demand for new loans falls. This would be likely to hurt banks and other lending companies, while housebuilders and estate agencies are also likely to be squeezed as housing affordability declines due to the higher cost of borrowing.
Travel and leisure stocks are also likely to endure a difficult period as consumer spending faces an uncertain period, while media and telecom companies may also decline due to reduced spending by consumers and businesses as many people and companies adopt a ‘wait and see’ attitude towards investment. Similarly, support services companies that rely on government contracts could also fall in value not just because of Brexit, but also because of the instability in government now that David Cameron has announced that he will step down later this year.
Clearly, this is a challenging time for investors, but the old rules still apply. Buying high quality companies in a range of sectors and that offer a diverse geographical exposure seems to be a sound strategy. And with Brexit now set to dominate the outlook for some time, there may not be a need to pile-in just yet.