Capital Markets: '˜Times are challening but there are opportunities to invest'

Sterling fell sharply from $1.50 to $1.32 in a couple of days. Large FTSE companies with significant overseas earnings went up as the value of those earnings in Sterling terms rose, but many domestically exposed stocks fell sharply. Particularly hard hit were banks and housebuilders, between June 23 and the lows on the July 6 Royal Bank of Scotland and Persimmon fell around 40 per cent whilst CYBG (owner of Yorkshire Bank) was a little more resilient, but still dropped over 27 per cent.

These initial reactions were largely predictable; indeed I wrote about them in this column a couple of months before the referendum. What is perhaps a bit more surprising is what has happened to the bond markets since the vote and just how well equities have done after the initial few days.

Instead of George Osborne’s threatened austerity budget, we have from Theresa May’s promise of a more flexible approach to the budget deficit. The Bank of England has also stepped in with an interest rate cut to help support the economy.

With any immediate threat of higher central bank interest rates removed, government bonds have done very well, in fact the yield available on 10 year Gilts has reached new lows at 0.5 per cent.

Few, if any, commentators would have predicted that investors would be happy to lend the government money for 10 years at 0.5 per cent interest rates given the extremely large deficit and inflation predicted to run around 2 per cent. This is not a great deal for savers.

Equities also reacted well to the prospect of rate cuts and less austerity and the FTSE 100 having fallen slightly immediately after the referendum was up almost 10 per cent on its June 23 level by mid August. Even the FTSE 250, with more domestic exposure, was up slightly by mid-August having been down over 16 per cent shortly after the vote.

Part of the reason for this may be the expectation that the UK will continue to have a strongly pro-business environment post-Brexit.

The progress Sirius Minerals has made getting approval for a controversial local Potash mine evidences this investment friendly approach.

All this reminds us of the unpredictably of events and consequently the difficulties of predicting markets. For investors the implications are broadly: 1) have a long term plan, 2) stay invested and 3) diversify. An investor saving for retirement 30 years or more away may be looking for significant growth and be able to tolerate the swings in valuation associated with an equity focused portfolio that can deliver this, whereas someone with a shorter term investment horizon and less requirement for growth may be better to have limited equity exposure.

Staying invested is important as there are always reasons to worry about markets and often the periods of strongest performance occur when these worries turn out to be overstated.

With the interest available from bonds near all time lows and considerable economic uncertainty casting a shadow over equities, investors face a challenging environment, but opportunities remain for patient investors.