Key points
- Indiscriminate selling after the U.K. Brexit vote may create opportunities in assets with positive fundamentals and relative value (such as quality and dividend-growth stocks).
- The U.K.’s shock decision pummeled global risk assets and the British pound, and buoyed safe-haven assets.
- We expect economic data this week to show poor U.S. jobs growth in May wasn’t a harbinger of a U.S. recession.
A British vote to exit the European Union (EU) has spurred a flight to safety, potentially creating opportunities. With most asset valuations looking fair to expensive, however, it’s important to focus on relative valuations.
Chart of the week
Prior to Brexit, there was a wide range of valuations but few cheap assets
globally, as shown above. Modest economic growth, low inflation expectations
and easy central bank policies have sent yields lower, intensifying flows into
income-oriented assets. This partly explains acute valuation differences
between equities and government bonds. Political concerns in Europe have
exacerbated other extreme differences.
Selectivity and caution are key
Valuations tell us little about short-term returns but can potentially shed light on medium-term returns. Starting valuations explain roughly 10% of U.S. equity market returns over the following year but 87% of returns over the next 10 years, according to our analysis back to 1998.
Valuations also show the risk of owning bonds (and bond proxies) could rise further, as market uncertainty and easy monetary policy potentially drive valuations of interest-rate-sensitive assets higher. Some assets may be cheap for a reason, reflecting structurally challenged businesses for instance.
The big takeaway for those seeking to buy into market weakness: Be wary of notionally cheap assets that face challenges (e.g., domestically focused European assets like U.K. real estate and European banks), and instead focus on assets with relatively attractive valuations and positive fundamental drivers, such as quality stocks, dividend-growth stocks and investment-grade bonds. Indiscriminate selling of risk assets could translate into buying opportunities in these assets, including in U.K.-listed stocks that benefit from pound depreciation (72% of FTSE 100 revenues are earned abroad). Bottom line: Post-Brexit, selectivity and caution are key.
