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Advisor Insights

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Will Brexit have a big impact in 2017?

It’s still an important issue, but companies will adapt.

By: SIMON AVERY

Date: November 29, 2016

As the United Kingdom begins figuring out how it’s going to extract itself from the European Union – its prime minister, Theresa May, now says the U.K. may not meet its 2019 self-imposed exit deadline – many investors are worried about how the ongoing uncertainty will impact their portfolios in 2017.

While there will certainly be some ups and downs, well-run businesses are likely to survive the upheaval intact, while savvy investors should be able to find several good buying opportunities, says Paras Anand, the head of European equities for Fidelity International.

In fact, Brexit may not be as bad for the economy as many people think. He points out that corporate financial results stand to get a boost from rising inflation, while the prices of stocks and other investment assets are being discounted by the falling value of the British pound.

“While Brexit may soak up a lot of political time, it may not necessarily be as negative to the broader economy or to the corporate sector as people say,” he says.

As for speculation around whether Brexit will actually happen – the country’s High Court recently said that Article 50 cannot be triggered without parliamentary approval –companies are proceeding under the assumption that an exit will take place, he says.

Still, what Britain’s departure from the EU will mean for its corporate sector remains highly uncertain, and the effects will likely vary from industry to industry, and possibly from company to company, depending on their market positions today.

In this environment, investors are best served by owning businesses with an ability to adapt.

“We look at a company’s flexibility,” says Mr. Anand. “How well set up they are, how well they are thinking through the process.”

While there are different working assumptions among businesses, most are running their operations as normal and developing contingency plans as they move forward. Still, no one can know for sure what might happen next.

“Most businesses we talk to expect to get clarity in increments over time, but very few expect to have a clear vision of what Brexit will look like,” he says.

Investors and advisors need to remember that Brexit is a political event rather than a structural phenomenon. At the end of the day, it “will affect companies at the margins,” says Mr. Anand.

To date, the referendum’s biggest impact has not been on the nation’s stock market, with the MSCI United Kingdom up 7.3 percent since the June 23 Brexit vote. Its currency, however, has fallen dramatically. Since the referendum, the pound has fallen in value by about 16 percent against the U.S. dollar, 13 percent against the loonie and 11 percent against the euro.

That’s made all assets, from stocks and bonds to real estate and intellectual property, substantially cheaper for Canadians to own.

Investors should expect the pound to rise next year, says Mr. Anand. He thinks it has likely hit bottom and that it looks undervalued today based on the fundamentals of Britain’s open market and on a broad-based international economy.

Company fundamentals should also remain strong in 2017, in part because roughly two-thirds of the revenues and profits from the country’s public companies come from abroad. Those revenues then get inflated when converted into pounds, which helps drive earnings growth.

Another lingering concern in Britain has been low inflation, but because the lower currency is making input costs for U.K. companies more expensive, Brexit could lead to a more normal inflationary environment. That would then boost the profitability of banks, improve lending and expand the money supply, he says.

The Bank of England is now forecasting that inflation will rise to about 2.7 percent by November 2017, which is almost a full percentage point more than it had anticipated before the referendum on Brexit occurred.

Ultimately, while there will be some impacts, it’s important for investors to be patient and not blow what’s happened out of proportion.

“We don’t downplay the importance of the referendum,” says Mr. Anand. “But it is a seismic political event with a macro-economic impact, not the other way around.”

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