A year after the Brexit vote, the UK has managed to avoid a bear market and recession. Still, global diversification remains a key tool for investors.
Fifteen months after Brits voted to leave the EU, the UK government is slowly ploughing ahead with Brexit. Invoking Article 50 of the Lisbon Treaty in March was the first major milestone. September’s EU Withdrawal Bill is the second. Investors sweated both events, along with the initial referendum, worrying each could bring bad market volatility. None did, and Britain’s economy and markets have taken Brexit in stride. Looking ahead, we expect Brexit to continue fading into the background as more cyclical forces keep driving stocks higher. Yet this isn’t a reason to load up on UK stocks. Regardless of your opinion on Brexit, we believe a global portfolio is best.
Even if you aren’t worried how Brexit might affect the local economy, you can still benefit by expanding your portfolio’s global reach. In our view, international diversification lowers the risk associated with investment concentration. It also exposes you to opportunities outside your country. All sectors and geographic locations fall in and out of favour. Global diversification can help smooth out these cycles.
Brexit Bear? Where?
Since the June 23, 2016 vote, the MSCI UK Index is up 22.9%—behind the MSCI World Index’s 34.6% over the same span, but hardly disastrous.[i] Much of the discrepancy has to do with the pound’s post-vote slide, which boosted Brits’ returns on foreign assets when converted back into sterling. This year, with the pound less of a factor, returns are much more even: The MSCI UK Index is up 7.2%, a hair behind the MSCI World’s 7.6%.[ii] Meanwhile, while UK economic growth has slowed this year, it remains positive, and GDP even accelerated a smidge in the second quarter.[iii]
Yet many pundits remain pessimistic. Some say the real trouble is already here, with UK inflation hitting four-year highs as prices rise faster than wages, creating a cost of living crisis that will implode consumer spending as goods and services become increasingly unaffordable. Others contend the reckoning will come later, once Brexit is official and the UK leaves the EU single market and the easy cross-Channel trade that comes with it.
We believe both viewpoints are overblown. Britain has weathered far higher inflation without experiencing a recession or bear market, both during this cycle (in 2011) and during much of the 1980s. A Brit in 1985 would have loved inflation at 2.9%, today’s annual rate. Short memories create false fears. As for the worries about a delayed reckoning, it is still too early to know what the Brexit terms will entail, so it is impossible to say whether the impact will be good, bad or neutral for the British economy. However, markets discount all widely known information, and Brexit negotiations lack surprise power. They are too public and too widely discussed to creep up on markets. Pundits have already spent months dissecting all manner of possible outcomes and likely keep doing so. This reduces the likelihood that anything Brexit-related can suddenly wallop stocks. In the meantime, we view the UK’s current political situation as positive for markets. Minority governments bring political gridlock, which generally reduces legislative risk—much to the benefit of equities.
The Logic of Global Diversification
With sentiment toward the economy and political scene unnecessarily dour, we expect UK equities to do well over the foreseeable future as reality beats dim expectations. Yet Britain is only one piece of a big global pie. The UK accounts for just 3.5% of the world economy and 6.6% of developed-world equity markets, based on market cap.[iv] Also, consider that 14 different nations have claimed the title of top annual equity market performer since 1997. Owning only UK stocks greatly diminishes your ability to invest where the best opportunities lie.
For example, UK markets tilt heavily toward the Financials, Energy and Materials sectors—much more than global markets. While UK Financials have outperformed the MSCI World Index thus far during this bull market, Energy and Materials have had a rougher road.[v] Both suffered as a global commodities glut placed tremendous pressure on prices and profit margins, lagging badly during the last three years and now behind cumulatively during this bull market. Meanwhile, Technology shares have surged in recent years, enjoying a solid run as one of the world’s strongest sectors. Technology shares, however, represent just 2.7% of UK stocks by market cap.[vi] To capitalize on this sector’s trends, you must invest globally.
Whatever your outlook on Brexit, we believe spreading your portfolio around the globe is the best way to navigate it—as well as markets over the long term. Brexit largely isn’t a factor for places like America and Asia, and it impacts Continental Europe far less than Britain. Owning these regions not only reduces your portfolio’s sensitivity to Brexit-related sentiment, but it exposes you to unique opportunities in these areas.
Investing in equity markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world equity markets and international currency exchange rates.
Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited Headquarters: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom. Fisher Investments Europe Limited’s parent company, Fisher Asset Management, LLC, trading under the name Fisher Investments, is established in the USA and regulated by the US Securities and Exchange Commission. Investment management services are provided by Fisher Investments.
This document constitutes the general views of Fisher Investments UK and Fisher Investments, and should not be regarded as personalised investment or tax advice or as a representation of their performance or that of their clients. No assurances are made that they will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts may be, as accurate as any contained herein.
[iii] UK Q2 2017 GDP up 0.3%. Source: Office for National Statistics, Released 26/07/2017.
[iv] Source: World Bank and FactSet, as of 18/07/2017. UK GDP as a percentage of global GDP and MSCI UK share of MSCI World Index by market capitalisation.
[v] Source: FactSet, as of 12/09/2017. MSCI UK Financials Index return with gross dividends and MSCI World Index return with net dividends, both in GBP, 6/3/2009 – 11/9/2017.