What's Next for British Stocks?

The 'Brexit' Reality That’s Still Settling In

••• Getty Images / Julian Elliott Photography.

The ‘Brexit’ referendum to leave the European Union narrowly passed in a 52% to 48% on June 24 and British stocks were quick to react. On June 24, the FTSE 100 benchmark index responded to the vote by falling 5.6% from 6,338 to 5,982 in just two days. The surprise came shortly after when the index rebounded to above 6,600 as of mid-July. Despite the negative consequences, it appeared that British stocks were faring just fine.

In this article, we will take a closer look at these dynamics and what they mean for British companies and international investors trading equities.

A Look Behind the Scenes

The FTSE 100 is similar to the Dow 30 in that the index represents just the largest companies within an economy. In practice, this means that these indexes aren’t terribly reliable when it comes to assessing the performance of the equity markets.

Many investors were surprised that the FTSE 100 fell only 5.2% in the days following the ‘Brexit’ vote, but that’s because they didn’t look behind the scenes to get the full picture. The FTSE 250 – more akin to the S&P 500 in the U.S. – fell a much more shocking 12.2% and still hasn’t recovered to its pre-‘Brexit’ levels as of mid-July. These details suggest that the British stock market hasn’t simply shrugged off the ‘Brexit’ – only its largest companies.

It’s important for investors to adjust the performance of these indexes by the value of the British pound, which has fallen sharply against other currencies.

After accounting for this performance, the FTSE 100 remains in negative territory in mid-July and the FTSE 250 remains substantially below its original value prior to the ‘Brexit’ vote. The performance also comes despite the dovish undertones from the world’s major central banks in response.

Effects on the Real Economy

The ‘Brexit’ represents a move into uncharted territories for both Britain and the European Union.

Since no country has exited the EU, there’s no precedent for how the process will occur, how long it will take, or the effects that it will have on the equity and bond markets.

That said, there has already been a number of effects on the real economy. Recent surveys have shown that businesses have cut spending and hiring amid the uncertainty, which could push the region into recession. The uncertainty alone could become a self-fulfilling prophecy for the economy as uncertainty that could last multiple quarters or even years weighs on business and consumer spending in the interim time.

The U.K. Treasury surprised the market by leaving its economic forecasts unchanged, while the Bank of England left interest rates unchanged. Many analysts believe that these organizations are trying to maintain confidence in the region through these actions. However, the effectiveness of the strategy remains uncertain given the real economic impact of the decision to leave the EU – and the potential changes to trade that are forthcoming.

The long-term impact of the ‘Brexit’ will depend on a number of different factors, including the trade negotiations that Britain must have with the EU. If Britain decides to impose trade barriers, the region could struggle with exports to its largest customers.

Any changes to immigration could also affect the region’s workforce – both inside and outside – and potentially jeopardize its status as a leading financial center for Europe.

The Bottom Line

The ‘Brexit’ may have had a benign impact on British stocks on the surface, but looking at the broader market and accounting for currency effects paints a very different picture. With some negative economic impacts already being reported in the real economy, the central bank and Treasury have taken a gamble in attempting to maintain confidence by keeping things steady. Many analysts believe the region could actually enter a recession over the near-term.

International investors should be cognizant of these impacts to their portfolio and think twice before investing in British stocks before there’s more clarity – or ensure that the British component of their portfolio is properly diversified.

With a number of big decisions regarding trade and immigration remaining, the performance of the real economy and stock markets could depend on the outcome of those negotiations.