After our initial commentary this morning, we wanted to further update you following our discussions with our investment partners. We will leave the press and media to mull over the causes of the result and we will concentrate on delivering level headed views we hope you will find useful.
UK markets opened in a similar way to another political surprise: last June’s Brexit referendum result. Sterling declined against major currencies with the FTSE 100 showing good gains. As per the last twelve months, we have seen an inverse relationship, when Sterling declines, the overseas earners within the FTSE 100 benefit.
We have built our portfolios to be resilient and forward looking with the ability to navigate through all types of event. The UK is an important market for us and naturally we all have a domestic bias, however this doesn’t dominate our thinking. The portfolios have global diversification and the ability to quickly move money into areas of value, expected growth and income generation. Our philosophy is not to over react but to make informed decisions in a timely manner.
We have spent the morning in discussions with our investment partners and we thought you would be interested to read their thoughts and what actions they will be taking in the funds they manage with us.
As investors greeted the start of the trading day in the City of London, the pound slid to a new low, sinking below $1.2650 against the dollar. It had climbed back above $1.27 in mid-morning trading. The FTSE 100 is up 0.85% and the all share is up 0.60% while the more UK-focused FTSE 250 slipped 0.7%.
SEI take pride in the ability to ride out these short sharp market shocks, we firmly believe the way to achieve that is by doing very little and avoiding knee jerk reactions – the portfolios are very global in their nature and we don’t expect a completely negative response, for example the weakness in currency is likely to be at least a short-term boost to those companies generating earnings from overseas, although Domestically-oriented companies are likely to remain volatile.
Prices for government bonds were mixed, pushing the two-year yield a touch lower. The 10-year gilt yield rose as a weaker pound was seen spurring further inflationary pressure. The market remains nervous about the idea of a hard Brexit and has at times reacted negatively to some of the harsher Brexit tone of the prime minister and her colleagues.
SEI believe that investors in well- balanced and well diversified portfolios are better positioned to achieve their goals, we still have high conviction in all our underlying managers to continue to drive returns through their unique investment styles.
Trying to rise above the gloom, clearly the result of the UK election is not what the market expected. But it’s worth remembering that the initial market reaction post the EU referendum and US election proved short-lived. A number of stocks that could be vulnerable under a more interventionist government have been weak for some time (eg transport and utilities), so this isn’t coming from a clear blue sky. Any sell-off in media and leisure stocks could prompt takeovers. However, if pressure on Sterling continues and the currency returns to the lower end of its recent trading range, dollar earnings for multi-nationals listed in the UK will be boosted. Remember the UK stock market is much less reliant on the domestic economy than in previous cycles.
In addition, the UK market has been out of favour with international investors for some time. Asset allocation to UK equities is already as low as it was in 2008 at the height of the banking crisis, so there is no sense of hot money leaving the market. The valuation gap with other equity markets, notably the US but also Europe, is as pronounced as it’s been for a decade on several metrics.
So lots of uncertainties and the domestic political and economic path forward is murky. However for UK equities the outlook is more measured and we will be looking for selective buying opportunities.
The unexpected outcome of the UK election further underpins our view that market volatility will move structurally higher in the medium-term. In anticipation of this, we reduced exposure to both equities and bonds back in February, in favour of absolute return strategies, that should do well regardless of market direction.
The election outcome results in heightened levels of uncertainty with regard to the UK’s exit from the European Union, and in the near term should see both the currency and UK local assets under pressure. Beyond this, however, the prospect of a “soft BREXIT” has grown under a hung parliament, and at some point this should start to be reflected in a slightly stronger currency. The UK economy is slowing, house prices are falling in London as consumer confidence has dipped and real wages have declined due to the higher cost of food and fuel. The second half of this year should see economic activity weaken further and lead to higher demand for UK government bonds, despite historically expensive valuations.
Sterling is now weaker than when the election was called and portfolios will have benefited from non – sterling exposure , we see no need to change our position. In the very short term increased uncertainty over the immediate direction of Brexit negotiations seems likely. However, it will soon become apparent that expectations for Brexit have become softer, suggesting that the Pound can resume its upwards progress. Negotiations with the EU may have to be delayed, increasing the the necessity for a transition deal that should cushion the impact of Brexit on the economy. While this result makes negotiations with the EU more complicated and difficult in the short term, it almost certainly makes the likely outcome softer. After all it couldn’t get much harder than the current path, and a soft, Norway-style Brexit represents the path of least resistance both for the British nation and for our biggest trading partner.
While the reaction of Sterling has been relatively muted, we expect continued uncertainty to keep the pound under pressure. The UK is still running a significant current account deficit and uncertainty could also weigh on household spending and business investment. At this early stage, the balance of factors look less supportive for domestic UK equities. In contrast, large cap UK equities, with earnings overseas, should continue to benefit from the currency boost to earnings provided by a weaker pound. This is where most of our exposure lies.
Going into the election, we have been positioned underweight UK equities, with a bias within our allocation to overseas-exposed corporates. We will be evaluating the situation as it evolves. Times of uncertainty can create interesting stock specific opportunities as pockets of value often emerge. As multi asset class investors, our portfolios have broad exposure to global companies, many of which can continue to benefit from improved global growth and earnings expectations that have little to do with UK politics.
The immediate uncertainty created by the result has been borne out in markets through a weaker GBP this morning. We had removed our position in the pound sterling in our active currency strategy on news of the election being called. As was the case following the UK referendum, this weakness is likely to offer a short-term boost to companies that list on the UK market and report in sterling, but generate revenues overseas – indeed the FTSE 100 has risen slightly on the election result, while the more domestically focused FTSE 250 has fallen. This does not represent a global risk event and there has been limited contagion in markets outside the UK. As things stand, our portfolio positioning has not been affected by the events overnight.
We continue to be in close contact with our investment partners and should we see any significant developments we will issue a further update. In the meantime we take comfort in the current positioning of the Portfolios. Looking back they have weathered various political and geopolitical events such as Brexit and US election results, designed to provide clients with a good outcome whatever is happening politically or otherwise within the world.
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