Who Caused the Stock Market Collapse? And consequences.

Who or what caused the stock market falls immediately after the Brexit vote? It was not just the UK market that fell, but many international ones plus of course the pound fell very significantly – to its lowest level since 1985. It was somewhat unexpected that the impact would be so immediate.

The UK stock market has recovered to a large extent in the large cap stocks, many of which will benefit from the lower pound and a move to more “defensive” stocks. But domestically focussed and smaller stocks are still down substantially.

As I said in a previous blog post, what seems to have happened is that overseas investors (who may know little about the detail of what might happen) have been dumping UK stocks wholesale. Bear in mind that such holders now have the largest proportion of the UK market. So they have particularly been selling FTSE-250 stock and those exposed to the local economy. Whereas those companies that have more international business and dollar revenues, and who benefit from the falling pound, have been more favoured. So why did they react in this way?

Reading my weekend Financial Times over breakfast this morning, I can see one reason why. Namely that the FT has been consistently negative on Brexit with repeated editorials forecasting doom and gloom (not just by the Editor but by their regular writers such as Martin Wolf and “guest” columnists). In yesterday’s edition we have a full page article by novelist Kazuo Ishiguro headlined “The remains of the UK” and asking “Did Britain really vote for xenophobia”. And we have an article by Tyler Brûlé (The Fast Lane) suggesting that London will become like depressed Montreal. Indeed the editorial approach of the FT has even been discussed in the letters page of the newspaper where one writer suggested the coverage of Brexit was “didactic”, i.e. somewhat doctrinal or pedagogic.

So was it the London based press including the FT that created a sense of impending disaster as a result of the Brexit vote in foreign commentators and investors? I would not be at all surprised.

This was compounded by widely publicised comments from Mark Carney of the Bank of England, and Chancellor George Osborne, plus of course the Treasury forecasts promoted by the Prime Minister. It is very worthwhile to watch this BBC video of former Bank Governer Lord Mervyn King: www.bbc.co.uk/news/video_and_audio/headlines/36642662 . He complains that the electorate were treated as idiots and that the incredibly accurate forecasts from the Treasury were very dubious. He also says both sides were exaggerating, which is surely correct, and complains about the negativity of the Remain campaign. He was baffled by the threat of an “emergency budget” which has of course now been abandoned.

So you can see why overseas investors might have taken a very jaundiced view of the result.

Unfortunately there are a number of people who obviously hate the result of the referendum vote, particularly those who may be personally affected in due course (EU citizens resident in the UK, scientists reliant on EU funding, etc). But surely that’s democracy for you. Up to 50% of voters do not get what they voted for! The reaction to the result seems particularly strong in the young who may have voted for the first time and are not used to “losing”. But this writer simply suggests that one has to accept the new situation and move on – effectively make the best of what the country has decided. So let’s look at a few issues of specific concern to individual stock market investors (i.e. ShareSoc Members) that have arisen:

1. Should we dump our small cap and FTSE-250 stocks and move into the mega-cap stocks (oil companies, miners) that have been favoured by overseas investors lately? Well John Lee, a very successful long term investor in small cap stocks, writing in this weekend’s FT gave his view with which this writer agrees: “Lengthy uncertainty lies ahead, exactly the background that business and the stock market hate. So what changes am I now contemplating in either my existing portfolios or in my investment approach? The answer is none, certainly in the short term”. Many of the stocks in the FTSE-100 that have done well in this period of turmoil are very mature businesses with few growth prospects. They often show a very poor return on capital and their reported accounts are frequently flattered by “exceptional” items. I cannot see that on a medium to long term view that many of these stocks will do any better in the next 5 or 10 years than they have done in the past few years. When picking FTSE-100 stocks you need to be just as selective as when picking small cap stocks.
2. One Member has questioned whether he will now be able to “retain his beloved share certificates” (the scrapping or “dematerialisation” of paper certificates has been driven by an EU Directive that mandated it by 2025). Having exchanged emails with the Government BIS Department on this issue I have to advise him that it seems unlikely that the Government will change its stance on moving to an electronic system. They were planning to consult on proposals in this area before the Referendum put everything on hold and still plan to do so but are likely to await for a new ministerial team to be in place (with a new Prime Minister in the offing, he/she will wish to appoint new ministers). ShareSoc has of course always supported dematerialisation because electronic share registration has many advantages – for example it can improve security. But we do need a low cost system that does not rely on the use of nominees (i.e. it needs to be a “name on register” system). See www.sharesoc.org/campaigns/shareholder-rights-campaign/ for a lot more information on our campaign in this area. It would be unfortunate if our exit from the EU was to delay such a positive move.
3. One particular consequence of an EU exit which may be more positive is the impact on EIS and VCT investments. Investors in the latter will be very well aware that the investment policies of VCTs have had to be changed because of EU state aid rules. In effect the UK Government had lost control over its taxation policies and support for the SME business sector. The end result was not only an exceedingly complex set of regulations that by themselves might have deterred investment but would have discouraged investment in certain types of business which were previously permissible and which had appeared to work reasonably well (supplying growth companies with finance while enabling investors to earn a reasonable return). We will have to see what transpires in this area but that is certainly one aspect that needs to be included in any negotiation with the EU and the sooner the better.

To conclude, the impact on individual stock market companies may be varied depending on their exposure to changes in exchange rates and the domestic economy. But any change in the latter is difficult to predict and certainly too early to do so. In any case, the Government and the Bank of England seem keen to step in with “stimulus” measures, such as even lower interest rates if necessary, so as to keep the economy in a reasonably healthy state. So the key as always is to try to invest in companies which are quality businesses that can weather any economic storms. Certainly jumping from one investment to another based on newspaper headlines is a sure recipe for eroding your longer term returns.

Roger Lawson