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Brexit throws up interesting punts - but caution still rules

With more uncertainty to come, analysts say there's no hurry to buy UK and European assets
Monday, July 11, 2016 - 05:50
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With the sterling down 10-15 per cent after Britain voted to leave the European Union, some investing or trading opportunities are looking interesting, including trophy assets like London residential property and hard-hit stocks like UK banks and homebuilders.

Singapore

DON'T jump in just yet. With the sterling down 10-15 per cent after Britain voted to leave the European Union, some investing or trading opportunities are looking interesting, including trophy assets like London residential property and hard-hit stocks like UK banks and homebuilders.

But analysts think investors should be in no hurry to act after "Brexit", given political uncertainty in Britain over the next few months as the ruling Conservative Party chooses a new leader and prime minister by Sept 9.

The contest has narrowed down to two people: pro-"Remain" camp Home Secretary Theresa May versus pro-"Leave" camp Minister of State for Energy Andrea Leadsom, an outsider who is fast gaining support among the Eurosceptic, right-wing elements of the party.

Most investors are meanwhile seeking refuge in corporate bonds. Gold, a safe-haven metal, remains popular, along with US equities.

"We are defensive but opportunistic," Bank of Singapore (BOS) chief investment officer Johan Jooste told The Business Times. "The best thing to tell a client now is to be ready to make a move, but don't rush it. There are more things to come, like Chinese banks and Donald Trump."

Mr Jooste was referring to bad debt risks in the world's second-largest economy, as well as the US elections in November. Mr Trump, a real estate businessman who has stirred disquiet among many, is in the running on a populist platform to become president of the world's most powerful economy.

On asset allocation, many investment houses are not enthused about European stocks, or any risky assets for that matter. Citing the need for income as yields go lower and uncertainties linger, analysts recommend that investors buy corporate bonds.

Hartmut Issel, UBS Wealth Management's head of Asia-Pacific equity and credit, said that the house is "overweight" EU high-yield bonds. The European Central Bank (ECB) will continue loose monetary policies if an economic fallout from Brexit lingers, he said. "Unlike their US counterparts, default rates are still very subdued, below 2 per cent, and are not expected to pick up in a major way over the coming quarters."

Asia and emerging markets still hold promise, some said. Analysts view the Brexit scare as localised to Europe and the UK, and note that low expected US interest rates will support emerging market assets.

Meanwhile, they also point to export-oriented stocks in the UK's FTSE 100 index and elsewhere in Europe as opportunities.

The analysts interviewed were speaking more than a week after Brexit, with the UK unexpectedly voting to leave the EU in a referendum on June 23. Since then, the British pound and banks in Europe have slumped.

Analysts say the fall in the pound is likely to attract investors to buy London residential property given the City's international appeal. Property values are thus unlikely to fall much.

Said Neo Teng Hwee, chief investment officer at UOB Private Bank: "London has been one of the favourite markets for the global rich if they want to diversify their assets, with its quality of life, transparent market, rule of law, and robust infrastructure."

BOS's Mr Jooste said one might want to wait until the end of the year. Rents might drop at the margins if banks, a major employer in the City, shift staff out. "Our clients are not exactly chasing it; they are just aware there's a potential opportunity," he said.

Guy Barnard, co-head of global property equities at Henderson Global Investors, said in a video update to clients that vacancy rates in general are still quite low. Supply will also be curbed due to uncertainty over the future of banks in London, he said.

"Areas such as student accommodation, self-storage as well as industrial assets, we think, are likely to prove much more resilient in an uncertain market. So we are very comfortable with the positions that we have," said Mr Barnard.

Elsewhere in Europe, the German residential market is a "very healthy structural growth story". Property stocks around the world in general might still perform well against other asset classes as the search for income will continue, he said.

Other than property, analysts highlight banks as potential trading opportunities. This is especially if the UK manages to wrestle some concessions from Europe in its exit negotiations.

Banks based in the UK are expected to lose their ability to run their European operations from London under single-market rules. Thus their stock prices have fallen 30 per cent or more in the past two weeks from already depressed levels.

Brexit-related fallout will mean that the bugbears of the European banking system - negative interest rates, the high cost of capital from regulatory burdens, and low growth - will remain, said a note from French asset manager Amundi.

"Do not succumb to panic, though. The banks in 2016 are different from the banks of 2008 or 2011 . . . valuation will be perceived as attractive at some stage," Amundi said.

Bond manager Pimco's Philippe Bodereau, a portfolio manager and Pimco's global head of financial research, said in a note that it is no surprise that Italian and Portuguese banks are down, given high non-performing loans and capital deficits.

But UK banks have high capital ratios, and large and liquid balance sheets, and have performed well in stress tests, he said.

Investors also need to distinguish between domestic retail and commercial UK banks and multinational banks based in the UK, where the former will face less disruption, Mr Bodereau said. On the other hand, BOS's Mr Jooste thinks global banks, with their broader international footprint, will be slightly better off.

Meanwhile, the UK's FTSE 100 is trading above its pre-Brexit levels, due to rallies in companies that will benefit from a weaker pound in sectors like consumer staples, oil, and pharmaceuticals.

Neil Dwane, global strategist of Allianz Global Investors, told BT in an e-mail that many UK and European stocks are already cheap, offer attractive dividend yields, and will benefit from weaker currencies.

"Weaker sterling may also attract corporate buyers of the better bits of UK industrials as many international segments rationalise and consolidate, which may also be true of media, consumer discretionary and services," he said.

In Europe, "a weakish euro will support EU exports at a time when domestic growth is slowing", Mr Dwane said. The corporate restructuring story will continue to reward shareholders with higher dividends and earnings, he said.

He suggests avoiding European banks, which he views as weak and politically vulnerable. "Many European companies in tech, consumer and industrials are well represented in the growing Asian and emerging market economies, and thus should be able to offer good growth for those looking for capital appreciation.

"Others offer strong and sustainable dividends, like oil, telcos and insurance, since income generation is also important for many clients in Europe and globally," Mr Dwane said.

Above all, investment advisors are wary of committing to risky assets like stocks.

The rise of populism might lead to higher taxation of corporates, import tariffs and more welfare benefits, said observers like Giordano Lombardo, CEO and chief investment officer of Pioneer Investments.

"All this means less growth and downward pressure on corporate profitability - which is a negative factor for equity exposure," he said in a note.

UBS's Mr Issel is avoiding IT-heavy Taiwan and Korea, where there are no major product cycles expected. He added that these two stock markets also derive 15 per cent (Taiwan) and 10 per cent (Korea) of their revenue from the EU - the highest among Asian markets.

Juan Nevado, portfolio manager of M&G Investments' multi-asset strategy, said in an e-mailed statement: "In my view, there has not yet been a big enough move to make a call on adding significantly more risk to portfolios."

Yet the most interesting asset classes to him at the moment are emerging market bonds and currencies, which can be supported by a delayed US rate hike.

He is also watching Japanese equities, the Mexican peso, the Australian dollar and Chinese equities - "all of which have seen significant price moves, despite fundamentals in these regions having little to do with Brexit".