OCTOBER 2019 MARKET UPDATE
So the 31st October Brexit deadline finally approaches.
Investors will rightly ask: what do we believe may happen, and how are we positioned ahead of it?
Well firstly, we should state the absolute difficulty around postulating any Brexit investment solution. The situation is so fluid, and investor reaction to a range of outcomes so unpredictable, we do not believe it is reducible by analysis or any amount of data crunching.
This heightened level of uncertainty (in the investment world everything is uncertain just as the future is inherently unknowable, only sometimes it is more uncertain than others) is precisely the reason that the price of UK equities has been depressed since the surprise initial vote result in 2016.
When assessing any threat, the two questions that should be asked are: ‘Is it real?’ and ‘What should be done about it?’ In our minds the two main risks that concern investors as a result of Brexit are a) a significant immediate fall in both short term (recession) and long term UK economic growth and b) currency risk ie a significant fall in the value of sterling.
Our response to this has, as previously discussed, been twofold.
Firstly, to look through Brexit and focus on valuations with the basic premise that whatever the outcome, there will be companies that do not have a material specific risk to any Brexit outcome. The price of Unilever for example, a global consumer goods company, is not defined or conditional on Brexit, despite the daily fluctuations in its share price being (at the moment) highly dependent on the Brexit newsflow.
In a similar vein, with currency it is easy to forget that approximately 80% of the FTSE100 earnings are actually derived from outside the UK.
The outcome of this is that it focuses our attention on the relative value of UK equity, which is cheap by both historical and relative standards. We therefore reiterate our belief that this asset class offers good value and remain overweight.
The second pillar of our approach is to build both a defence and liquidity.
The defence has been to mitigate risk elsewhere in our portfolios. We have concentrated our debt investments in less volatile short duration sovereign issues from the UK and US only, and also in high quality asset backed debt. There is nothing long dated, no junk debt, and no negative yielding debt. The significant holdings of US treasuries provide us with a yield improvement and, given they are denominated in US dollars, a currency hedge.
Our investment in gold, also being denominated in dollars, provides a further currency hedge as well as a defence against other possible events that would make people sell risk investments.
All of these defensive, low risk assets have performed strongly for us over the last three months.
Liquidity: during this period we have also accumulated further cash from selling UK equities when the FTSE100 was over 7600 (7200 today) and from reducing our debt investments. This provides us with a further substantial cushion should stock markets decline and the fuel to take advantage of opportunities to invest should stock market prices tumble.
While we make no predictions about the mechanism or fact of Brexit, it does appear from the politics that the next fortnight is likely to be decisive. Brexit will either happen or it will be kicked into the long grass for at least the rest of this year but we are likely to have visibility over which of these outcomes will arise relatively soon.
The spike last week in sterling and the UK stock market when it appeared the politics relating to a negotiated deal improved, spoke volumes about how the UK stock market has been held down by this uncertainty and negativity. The moment the uncertainty eased, even if only momentarily, then UK risk assets jumped.
This is a strong signal that the UK stock market is trading some way below its intrinsic value. It is like a balloon being held underwater by Brexit; any diminution of downwards pressure allows the balloon to rise.
Finally, it is also worth noting that overseas investors are also very underweight UK equities, which we take as a further bullish sign as this signifies a large amount of potential demand sitting on the sidelines waiting to buy.