Who in SA should worry about Brexit impact?

Cape Town - When pondering the possible impact of Brexit for South Africans, it is important to distinguish between investors and non-investors, Izak Odendaal, investment strategist at Old Mutual Multi-Managers, told Fin24 on Monday.

"It looks like Brexit is going to be a bit worse than initially presumed. Compared to the initial reaction after the vote, the months since then have looked a bit better for the UK. However, what we saw last week were the financial markets saying things are probably not going to be as rosy. There is still lot of uncertainty," explained Odendaal.

"For the non-investor in South Africa - in other words the 'man in the street' in general - I do not think Brexit is going to be that big a deal. The impact on the global economy and the SA economy is likely to be limited. For SA investors, however, things are going to be a bit more interesting as quite a few companies on the JSE have exposure to the UK economy. Therefore, the pound earnings translated back into rand will now be lower. So, in that sense you have an impact for SA investors at least for now when the pound is weak."

Odendaal added that one has to remember the rand is still quite weak against the pound relative to where it was a few years ago, but since the start of year the rand is definitely stronger against the pound.
"Brexit was off the radar screens for the last two months, but it is now again on the radar screens of global investors. In terms of managing our strategies, however, here we are not making changes to asset allocation based on Brexit information from the past week. We always remind investors to take a long term view," explained Odendaal.

Friday morning saw a "flash crash" in the UK pound when its value slumped by 6% in Asian trading to $1.18 before rebounding two minutes later to $1.24. Other currencies – including the rand – reacted negatively too.

According to Odendaal and Dave Mohr (also an Old Mutual multi-manager), it is unclear whether a technical glitch or human error was behind the sharp slump, but the pound had already been falling for most of the week after Prime Minister Theresa May outlined her government’s intentions regarding its future relationship with the European Union.

READ: Brexit talks shouldn’t aim for punishment: EU’s Moscovici

It included curbs on immigration that would go against the EU’s key principles of free movement of goods, services, people and capital and, therefore, could see restricted access for UK companies to the European single market. Such an outcome has been termed a “hard Brexit”. May said she intends triggering Article 50 of the Treaty of Lisbon by March 2017, which would set the process of leaving the EU in motion.

"On the positive side, there are increasing signs that May’s government will lean to infrastructure spending as a way to support the economy during the potentially turbulent years ahead, instead of just relying on the Bank of England to do the heavy lifting. This would represent a marked break with the austerity policies of her fellow Conservative predecessor David Cameron," explained Mohr and Odendaal.

"It could also act as an example for other governments to use low borrowing costs - the UK government can borrow at only 1.4% per year for 30 years - to fund investments that would lift productivity and growth. The International Monetary Fund (IMF) has been calling for this for years now."

The IMF forecast for the UK this year is 1.8% and 1.1% for 2017, but there is considerable uncertainty over this outlook since no one knows exactly how Brexit negotiations will play, according to Mohr and Odendaal.

"Buoyed by the weaker currency, the FTSE 100 surged above 7 000 points, the highest level in a year. Much like the JSE, the London bourse is dominated by global companies whose revenues rise as the pound falls," they said.

READ: Brexit could take 10 years - expert

Brett Birkenstock and Kirk Swart of Overberg Asset Management, pointed out that the UK is one of South Africa's biggest trading partners. Brexit, therefore, 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," they said in their weekly sharewatch column on Fin24.

"However, exporters (farmers, manufacturers and the like) will struggle to be competitive under the current rand rate. Tourism from the UK might very well drop off as it becomes expensive for UK citizens to travel abroad," they explained.

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, they pointed out. 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," said Birkenstock and Swart.

"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."

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