Uncertainty grows for FTSE 100 investors

As uncertainty grows, investors will get back to basics, writes Tom Stevenson

A large computerised display of the British FTSE 100 index is pictured in London
London's benchmark index is back to where it was a fortnight ago Credit: Photo: AFP

In the short-term the No vote was clearly the better outcome for investors. It takes big economic uncertainties off the table and underpins the recovery. It was not surprising that sterling and the most exposed areas of the stock market responded so enthusiastically.

Longer term, the picture is less clear-cut. All that happened on Thursday was a shift in the focus of the debate from economics to politics. The referendum was a way-station on a journey towards a looser confederation. That evolution is hard to quantify and markets hate what they cannot measure.

The No vote was still preferable from a market perspective. The unanswered questions around the currency, how to balance the budget, divide the debts, share North Sea oil and regulate financial services are so fundamental that a Yes vote would have led to reduced investment, lower confidence and, most likely, a significant slowdown on both sides of the border.

By recklessly underplaying the risks until shaken out of their complacency, the Unionists were in the end forced to write an open cheque to secure victory. The reverberations of “devo max” will be felt around the UK, and further afield in Catalonia and elsewhere, as Britain’s other regions are empowered to ask what they might get out of the forthcoming constitutional revolution.

Over the summer months, investors were able to shrug off a surprising number of unknowns. Geopolitical risk in Ukraine and the Middle East, economic uncertainty in the eurozone and China and a lack of clarity around monetary policy on both sides of the Atlantic – even in combination these were not enough to prevent the market climbing the wall of worry.

As we navigate the difficult months of September and October, domestic politics is now thrown into the mix. The general election and a possible EU referendum are as likely as the Scottish vote to be too close to call. Over the pond, the November mid-term elections threaten to reopen wounds in America’s dysfunctional Congress.

The market’s sanguine response to this heightened uncertainty may not be as wide of the mark as it looks, however. That’s because, once the relief rally is over, the pound may run out of steam again. That would be welcomed in Britain’s internationally-focused boardrooms, where a common theme this summer has been the difficulty of growing profits and dividends under the weight of an overvalued pound.

One of the reasons why sterling might fail to regain its lost ground is that the Bank of England now has cover to keep interest rates lower for longer. It is hard to see the Bank turning hawkish faced with prolonged political uncertainty. Weak sterling and lower interest rates create a pretty benign market backdrop.

What’s the best way to play the new environment? First, I expect investors to get back to basics in the absence of clarity about the political context. Outside Europe, where a new wave of stimulus could lift all boats, markets are likely to become more discerning. There has been no benefit in spotting good companies in recent years because they’ve performed no better than the dross as everything floated on a tide of liquidity. Stock-picking will count again.

Second, after domestically-focused companies have bounced, large reliable companies, with diverse international businesses, will outperform small and mid-cap stocks. In an uncertain environment, investors will focus on safety and reliability.

As Europe, including the UK, looks inwards over the next couple of years, America’s recovery, buoyed by a rising dollar, will look increasingly attractive to investors. Reliable growth and sustainable dividends will be at a premium.

Five years from the start of the current bull market, we are entering the final phase in which brave investors will be able to capture good returns. The price they will pay will be higher volatility. Anyone who stayed up to watch the results on Friday morning may have had a taste of sleepless nights to come