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Cape Town - The Brexit vote was a big shock to global financial markets. The pound is trading at record lows as uncertainty over the financial future of the United Kingdom (UK) is spreading across the continent and around the world.
Theresa May, the newly appointed British Prime minister, has indicated that she will trigger Article 50 by March 2017, after which the UK will have two years to officially exit the European Union (EU).
So what does it all mean and why has the pound suffered such big losses since June? What does it mean to South Africans?
Market uncertainty
So why did the pound drop from R21 to R17 since June 2016? On the eve of 23 June 2016, the UK was still part of the EU. One pound was selling for R21.41 while the euro/pound was €1.30. A referendum had been called by David Cameron, the British Prime Minister at the time, to vote on whether the UK will leave the EU. Choosing to leave the EU was seen by the majority of analysts and commentators as highly unlikely. Why would any European nation make such a risky call as to leave the EU?
Against the opinion of most analysts, commentators and “polls” the British people voted to leave the EU. The unexpected had become a reality and if there is one thing that markets do not like, it is uncertainty.
The UK central bank has indicated that they are ready to act and lower interest rates should Brexit cause the economy to slow down. Expectations of lower rates have resulted in a weaker currency, with money leaving the UK for emerging markets such as South Africa, India, Brazil and other counties which have “yield”.
Another factor that has caused the pound to fall is that when a country leaves a trade block like the EU, capital and goods can't flow freely across the border. This places pressure on the UK to re-negotiate separate trade relations with each of its trading partners.
Much of the pound weakness is due to the uncertainty over whether the UK will be able to successfully re-negotiate all of its trade agreements and whether or not London will remain the financial hub of Europe.
What does Brexit mean for ordinary South Africans?
The UK is one of South Africa's biggest trading partners. Brexit implies that new trade agreements will have to be agreed upon. Our wine and fruit industry might very well welcome new trade agreements as the current agreements are very strict.
However, exporters (farmers, manufacturers and the like) will struggle to be competitive under the current ZAR rate. Tourism from the UK might very well drop off as it becomes expensive for UK citizens to travel abroad.
The weak pound has caused some JSE-listed companies with UK exposure to drop in price. Capco [JSE:CCO], Mediclinic [JSE:MDC], Discovery [JSE:DSY], Reinet [JSE:REI], Brait [JSE:BAT] and many more have all de-rated. These companies, which earn some, if not all of their revenue in the UK, will now earn less pounds for each rand, resulting in the price drop.
Despite the drop in share prices there are positives that go along with the stronger rand. A strong rand is good for consumers as prices tend to drop with the lower import prices and cheaper logistics due to lower fuel prices.
For lenders, interest rates are unlikely to rise as inflation is set to fall. Travelling abroad also becomes cheaper and the current rand strength may help South Africa avoid a downgrade in December.
Has the pound sell-off been overdone?
Markets tend to over-react, resulting in exaggerated movements in different directions. With Brexit, this is/will probably be the case – however, it is very hard to determine the exact level with so many variables at play.
The uncertainty over whether the UK will successfully leave the EU and broker new trade agreements has caused much of the pound weakness. Over the long-term, chances are that the negotiations will go well and that much of the “hard Brexit” fears are overdone. This might offer a good opportunity to buy into the UK exposed shares.
After a long period, investors are finally seeing some value again from shares such as Reinet, Brait, Capco, Steinhoff [JSE:SHF] and many others.
* Kirk Swart and Brett Birkenstock are analyst sat Overberg Asset Management, an Authorised Financial Services Provider (No 783) which specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: The above article does not constitute financial advice and is not a recommendation. Investors must always seek the advice of professionals and trade with caution. Under the ECT Act and to the fullest extent possible under the applicable law, Fin24 disclaims all responsibility or liability for any damages whatsoever resulting from the use of this site in any manner.
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