Why have stock markets bounced since the Brexit vote?

Posted on February 2nd, 2017 | Categories - Investments

The referendum of 23rd June 2016, that began the UK’s journey out of Europe, delivered a seismic shock not just to the UK stock market, but to markets around the world.

However, after some frightening rumblings, the economic landslide never happened. There was a marked initial dip, but since then the UK stock market has surged ahead.

Why has this happened, and is it all good news?

Hours after British citizens voted to ditch the European Union, global stocks took a historic two-day tumble. But not only did they soon stabilise, they have since steadily grown to historic highs.

Britain’s economy continued its bounce from the initial shock of the Brexit vote with a speed that has surprised many investors. Reports from the Bank of England and the Office for National statistics suggest that both investors and ordinary British citizens feel positive about the nation’s economic future. Even the European commission upgraded its growth forecast for UK economy from 1% to 1.5% earlier this month.

Fears not founded?

Market sentiment before the vote was cautious. At the start of 2016, most investors had a fairly negative outlook. Markets were down around the world, and there were serious concerns over deflation and the ability of central banks to provide support on a scale large enough to improve the situation.

The UK market in particular was primarily focused on the EU referendum and the majority of sectors were subdued. In the run up to the vote, there were some big sell offs. Domestic sectors bore the brunt with financials, consumer services and telecoms all suffering.

The mood was fearful. But the poor performance of many sectors before the vote simply meant that they were in a strong position for the rest of the year, as lower valuations made them more attractive.

The power of the cheap pound

The UK stock market has undoubtedly been boosted by the cheap pound with the value of Sterling falling against the Euro, and other currencies, since the Brexit vote.

This has a number of effects on the economy. Imports are more expensive, which can be a significant in sectors like energy – oil is priced in dollars. The cost of filling your tank has gone up, and so have energy costs to UK industry. Imported food and foreign holidays are both also more expensive as the result of less favourable exchange rates.

But, for some, a cheap pound may be no bad thing. If imports are more expensive, exports are much cheaper, providing a powerful stimulus for UK exporters.

Many of our biggest global companies are seeing higher overseas earnings thanks to the devalued pound. The improved prospects for the UK based global giants has driven the FTSE 100 of blue chip shares to new highs, and has stimulated a major rally in the stocks of FTSE 250 firms.

The effect can be seen in real terms, with production of British made cars climbing, while some German manufacturers are scaling back.

Consumer confidence

The recovery in exporting due to a cheap pound seems to have boosted business outlooks and employment prospects, which in turn helped fuel a surge in consumer confidence.

Of course, these are still early days. But with much of the pessimism around the Brexit vote now dispersed, consumers are apparently willing to spend money in the High Street and beyond.

Whatever damage was done to UK consumer, and business confidence, in the days after the referendum result, it seems to have been quickly overcome. The simple fact is that if consumers are buoyant, then business and investment should expand to serve their needs.

It is of course too early to say what the long-term effect of Brexit will be. The terms of the exit itself have not been decided and they are key to understanding what exactly the future may hold.

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