Post-Brexit Maneuverings
In July, the International Monetary Fund slightly trimmed its forecasts for global economic growth both this year and next because of Brexit’s impact on already-fragile business and consumer confidence.
The IMF said the U.K. and Europe will take the biggest hits, which will crank up the pressure on policy makers to strengthen banking systems and make good on much-needed structural reforms. “The real effects of Brexit will play out gradually over time, adding elements of economic and political uncertainty,” said Maurice Obstfeld, IMF chief economist and economic counsellor, in a news release announcing IMF’s world economic outlook update. “This overlay of extra uncertainty, in turn, may open the door to an amplified response of financial markets to negative shocks.”
So how to invest in this type of environment?
“It’s very hard to figure out what exactly to do,” says John Maxwell, portfolio manager of the Ivy International Core Equity Fund. “For sure, I don’t want to be overweight domestic Europe.”
Maxwell says he’s defensive from a balance-sheet standpoint, but that his fund owns its share of cyclical stocks because some of them are too cheap to ignore. “The market is kind of bifurcated between 10 times earnings and 20 times earnings stocks, with the 20 times generally being defensive, high-quality, stable dividend payers and the 10 times being cyclical companies,” he notes.
One of the positions Maxwell’s fund recently added was Adecco, a Swiss provider of human-resource services that got hit during the Brexit downdraft. “People thought Brexit would hurt the global economic cycle, so people sold early-cycle stocks like temp services,” Maxwell says. “But the temp services industry is transforming itself, and Adecco is a low-risk company with a 5% dividend and trades at about 10 or 11 times earnings.”
Another cyclical stock he likes is Bridgestone, the Japanese tire maker which he says offers compelling value (about 10 times earnings), a net-cash balance sheet and a yield of more than 3.5%. “It’s hard to ignore a business like that, which we think is a strong survivor,” he says.
Maxwell also added to his fund’s position in Nestlé, the world’s biggest food company. “It has a great CEO, trades at around 25 times earnings and pays a nearly 3% dividend,” he says.
Rick Rieder, chief investment officer of global fixed income at BlackRock and portfolio manager of the BlackRock Strategic Global Bond Fund, says recent events have caused him to focus his fund’s portfolio on conservative risk. He believes Brexit will be a drag on European and U.K. growth, which in turn will weigh on interest rates there.
“As long as we’re in an environment of sluggish growth, low rates and the dollar not appreciating, that’s nirvana for the emerging markets,” Rieder says. “With many developed markets at negative yields or zero, there are places like Brazil, Argentina and Indonesia or even Mexico that have significantly positive real yields.”
To diversify risk, he likes bonds in countries where rates will remain low for a while, such as Australia, Europe and parts of Asia. And he was long the Japanese yen, a position he says performs well in a risk-off environment. “So we’re being more conservative than normal, but also looking tactically at what will do well,” Rieder says.
Other Options
Kevin Simpson, founder and portfolio manager at Capital Wealth Planning LLC in Naples, Fla., says he successfully employed a covered call strategy heading into the Brexit vote because he felt the market had run up aggressively into the referendum and expected the market to take a breather after the news. What he didn’t expect was a “No” vote, prompting him to joke that sometimes it’s better to be lucky than smart. That said, he believes covered calls are always a good way to counter volatility.
“I use covered calls to act as a modest hedge in our portfolio to help buffer the downside of any pullbacks to the extent of the premiums we bring in. We’re always hedging to try to take advantage of volatility. The byproduct is that it generates cash flow, which is appealing in respect to where interest rates are right now.”
Keith Springer of Springer Financial Advisors in Sacramento, Calif., likes gold as a deflation hedge. “Brexit means continued deflation, which will depress earnings for corporations in Europe, and especially in Britain,” he says. “We’ll see more stimulus from the European Union, which will keep rates down and which will increase deflation that’s a hindrance to growth.”
And he favors U.S. stocks. “I’d stay away from European stocks, at least until you know what comes of Brexit.”
Ben Hunt at Salient focuses on real assets and real cash flows that are less exposed to policy-driven storms. “I have an expansive definition of what real assets and real yield can be,” he says. “It can be real estate, energy pipelines, intellectual property. Those investments won’t match whatever the casino-driven benchmark might be. I don’t expect to beat the S&P 500 by owning a stock that’s slow and steady and gives me a reasonable yield.”
Brexit might be a shot across the bow regarding Europe-induced global financial, economic and/or political mayhem. Then again, maybe not. Regardless, it’s probably only a matter of time before something new hits the fan—which might be the ultimate takeaway from Brexit.