Brexit Hangover, You’re Not Laughing Now

The markets falling, England lost to Iceland in a football match, and there is gloom and despondency everywhere. Much of the country seems to be in a post-party hangover. It therefore seems a good time to review the situation and try to give some explanations for what has been happening.

Firstly, you have probably guessed, as did my local M.P. without me telling him, that I voted for Brexit. Je ne regrette rien, as one of our partners that we intend to divorce might say. There were clearly some risks to the economy, and to particular sectors, but I judged them to be longer term rather than short term. The key for me was that I wish to live in a democracy, not a bureaucracy. But it is likely to be two years or more before we are out of the EU, and that’s even assuming there is no further renegotiation to keep us in or some other fudge devised by those in Parliament who oppose it. Even George Osborne has decided he does not now need an emergency budget after all – the threat was surely part of the “project fear” campaign. So the rapid decline in sterling and some shares was somewhat surprising.

And just to make it clear to Ms Sturgeon in Scotland, and Mr Khan in London, Parliament has the ultimate authority to take us out of the EU based on the Referendum result, if they choose to do so – or not as the case may be. Also Ms Sturgeon cannot invoke another Scottish independence referendum or block an EU exit without the consent of the UK Parliament.

What seems to have been happening in the last few days is that overseas investors (who may know little about the detail of what might happen) have been dumping UK stocks wholesale. Bear in mind that such holders now have the largest proportion of the UK market. So they have particularly been selling FTSE-250 stock and those exposed to the local economy. Whereas those companies that have more international business and dollar revenues, and who benefit from the falling pound, have been more favoured.

As the pound falls, so the perceived prices of UK stocks viewed from overseas falls, so it has encouraged a stampede to exit. But then UK businesses start to look cheap so we might see some takeover activity in the long term but the earnings also look cheaper of course. Those that have exports and hence income in other currencies might be particularly favoured. However, these effects take time to work through when at present we are in an irrational and short term state of panic.

Both commercial property and house-builders have been particularly badly hit. The former by the threat to London office demand as folks allege that the financial sector might move thousands of jobs out of London (to Frankfurt, Dublin or elsewhere). This seems to be based partly on the possible threat to “EU Passporting” capabilities for financial services (although the FT reported that might not be at risk after all) and by the EU attacking the dominance of London in that market. Whatever transpires, it does not seem likely to me that this will happen overnight. Moving such business is not a simple task and most commercial property companies have longer leases so the tenants have to keep on paying regardless. In addition the proportion of City/West End space let to Banks and Insurance Companies is less than you might think and has been coming down (even British Land whose share price fell by 25% only has 38% of its lettings to banks and financial services companies). In extremis, offices can be converted to other uses. In addition many UK listed property companies have substantial holdings in Europe and TR Property Investment Trust, one of the most popular general property holdings for private investors, has 50% of its holdings in European properties and companies.

Banks were also badly hit allegedly on the threat of a downgrade to their credit ratings, and in sympathy with the Standard & Poors downgrading UK sovereign debt. But the exact impact on banks of Brexit is not at all clear.

Actually it may not be a bad thing for the UK economy to lose some of its financial sector work. The UK economy is way too over-dependent on the financial services sector which is why the financial crisis of 2008 hit the UK very hard in comparison with other countries. Indeed it became Government policy to develop a wider spectrum economic base.

House-builders have fallen because of the possible “lack of confidence” engendered in house buyers and reports from London that the market is slow and prices falling. But London is not the country and it has been recognised for some time that the market for high-end properties has over-heated. But the fall in the pound actually makes UK property cheaper for overseas buyers, where a lot of them come from for such properties. For houses in general it’s worth noting that Rightmove reported recently that house price sales in May were at a record low in terms of duration, i.e. houses are selling faster than ever. If it’s slow now then that’s probably just the traditional slump in the summer months. It’s also worth noting that HSBC has been offering a record low interest rate of 0.99% (two year fixed rate) and the demand for new houses is driven by the structural deficit in the house sector and the availability of low costs mortgage. Neither factor is likely to change in the short term. A growing population needs more housing and with not enough production that will not change for years.

Will the lack of immigrants reduce the demand? No because not only is the demand still there, but in the next two years the number of immigrants may actually rise as they try to pre-empt any restriction. In any case past immigrants are mainly young and fertile leading to a rapid “organic” growth in the population as they procreate.

So in this writer’s view the worries about the commercial property and house-building sectors are grossly overdone.

Other companies badly affected have been banks, retailers, and others focused on the UK economy. So companies such as Whitbread and Restaurant Group have fallen back. Will we drink fewer coffees, consume fewer leisure meals, or rent fewer cheap hotel rooms? I doubt it – at least not in the short term. Any impact on these companies surely depends on a wide general recession in the UK but one can understand why overseas holders might be selling in panic mode. Retailers such as Dunelm and Topps Tiles have fallen substantially. Will UK buyers buy less homeware or stop refurbishing their houses? That seems unlikely, but those companies might be affected by the large amount of goods they import which may be at higher prices.

What’s the impact on companies such as Whitbread who you might think employ a lot of low cost immigrants? Firstly the supply may not change much as pointed out above. And secondly they are not as high a proportion of UK shop, hotel and restaurant workers as you might think which is only 8%. As usual the view of Londoners where most of the scribblers reside may be distorted in relation to the whole country.

There is the general impact of the falling pound to consider of course. Many companies will benefit. Indeed many countries of late have been in a “race to the bottom” to reduce their interest rates, reduce their currency value and hence boost their export economies. So oil companies such as Shell and BP and major exporters such as Rolls-Royce and Diageo have actually seen their share prices rise. Companies such as National Grid have also benefited from their “defensive” nature and the fact they have major overseas businesses. But smaller companies have been the victim of the “sell everything” stance of foreign investors.

Those companies that are very UK focussed and which are unlikely to be affected by short term economic trends have been particularly badly affected – for example EMIS who primarily sell to the NHS and which has fallen 20%. Will the Government be reducing health service expenditure? That seems highly unlikely even if there is a general recession.

So my conclusion is that if you are a UK based investor, then some of the recent price falls have made for buying opportunities. Certainly I have been purchasing stocks as have many other private investors it is reported by trading platforms. But the key is to pick out the irrationally priced companies from those that might be affected in the longer term.

One final comment. It is interesting to speculate what might happen to UKIP, a party with a single policy which they have now achieved. At least they might soon do so. Will they wind-up as many wish who hate the “popular” style of Nigel Farage or transmogrify into a more broader based policy platform? Mr Farage repeated his quip which I had heard before to the European Parliament yesterday when he said that when he first joined the Parliament many years ago and said he wanted the UK to leave “You all laughed at me. Well, you’re not laughing now”. This is of course a paraphrase of Bob Monkhouse’s classic joke “When I said I wanted to be a comedian, everyone laughed at me. But you are not laughing now”. That resonated well with UK audiences but fell flat on Euro MEPs.

We could certainly do with a few more laughs in the current state of political affairs.

Note that the writer of this note holds some of the stocks mentioned therein.

Roger Lawson