Taking Stock: Brexit and the markets
There’s been a lot of economic modelling in the news lately as the Brexit debates roll on. Steering well clear of any politics, what’s the potential impact of next week’s vote in parliament on the markets and our investments?
The possibilities outlined by Mark Carney were stark – but it’s important to remember he was talking about the worst-case scenario, the extreme that might occur according to his modelling.
As always, knowledge is power, so let’s go beyond the headlines and look at how the coming weeks and months might affect you as an individual investor (remember, if you have a pension scheme then that means you).
Deal or no deal?
If the deal proposed by Theresa May is passed through parliament, I think it would be a positive sign for the UK stock markets, which like certainty and dislike uncertainty. They are forward-thinking machines, looking into the future and asking, ‘What’s likely to happen in the future?’ Share prices are then priced accordingly.
When markets don’t know what’s going to happen, we see a lot of volatility. If May’s deal passes, that will create more certainty, which should help them become more stable.
In that scenario, if the markets pick up, the economy is likely to pick up, which means interest rates are likely to slowly rise. If that happens, we’ll likely see some slowing of property growth, but that might not be a bad thing for the country – it helps first-time buyers get onto the housing ladder, and increasing interest rates also mean savers may also enjoy better returns. At the very least, we should see better yields being paid by government or corporate bonds.
If on the other hand there’s a no deal Brexit, with no agreement with the EU, that provides more uncertainty for the markets – and more volatility. Nobody knows how long that could last for, but I’d estimate it could be up to two years, perhaps three.
If you’re a retiree drawing down money from your pension, or you have a capital sum you plan to live off, then act now. You want to make sure that you have at least 36 months, and possibly 60 months, of your income in low-risk investments: cash or low-risk bonds. That will give you certainty in the short-term and mitigate the volatility elsewhere.
Think global, not just Brexit
If you look at a chart of the world’s stock markets by size, you’ll see that the US represents 54% of the value of the overall world stock market. The UK comes in at around 6%, with France, Germany and Switzerland all at 3%, and the Netherlands 1%. Europe combined makes up around 18% of the global value.
Those numbers show that Brexit is only directly creating volatility in a minority of the world’s markets. Although resulting trade implications may affect the US, I’m not convinced it will affect the US stock market as much as some think: if you compare the past months of Brexit-driven volatility in Europe, until very recently the US S&P 500 has just continued to climb regardless.
There are of course other considerations which affect the US, such as the current trade standoff with China, but Brexit itself has not had a major impact.
What does that mean for you as an individual?
First, it means that when you invest you should be diversifying globally. The traditional, now old-fashioned way to invest was to have a ‘home bias’, with at least half of your investments in your domestic markets and the rest split globally.
A lot of academic research has shown that there’s nothing to warrant that approach. By diversifying more of your portfolio to the global markets, such as that 54% chunk that the US contributes, you reduce your risk and you gain exposure to some of the world’s biggest companies such as Apple, Google et al.
Second, it’s a reminder of the two most important considerations for your investment portfolio: make sure your level of risk is compatible with both your tolerance and your capacity.
Your tolerance could be defined as how well you can sleep at night when your portfolio value falls; your capacity is how much of a fall would affect your standard of living, as it did for some after 2007. Typically, the market will fall around 50% in a big retraction such as the dotcom bubble in 2000 or the financial crisis of 2007/08.
If you’ve got enough cash or low-risk bonds in your portfolio, or you’re sufficiently diversified globally, then you should be fine weathering any Brexit-related storm.
Uncertainty isn’t ideal. We want things to run smoothly, and so do the markets. But regardless of your opinion on Brexit, it’s on the horizon, so look at the things you can control and act where needed:
- Diversify your investments globally, not just in the UK
- Don’t take more risk than you need to or than you can tolerate
- Don’t’ change your investment strategy based on the politics of the day. Your strategy should be a long-term one, and you should stick to it
- If you’re drawing income from your investments, hold at least three years’ of income as cash, or cash equivalent such as low-risk bonds, to carry you through any rocky periods
After that, sit tight and evaluate. Your pension statement valuations might go up and down for the next couple of years, but over the long-term the markets riset. Being prepared means you needn’t be too scared.
Warren Shute was named the UK’s Certified Financial Planner of the Year in 2017. His best-selling personal finance book, The Money Plan, is available now on Amazon