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React to Brexit chaos, or keep calm and carry on?

Dan Kemp  |  20 Nov 2018Text size  Decrease  Increase  |  
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Theresa May Prime Minister

People love to talk about Brexit, and investors can be tempted to trade based on expected outcomes. We believe the investment basis for this is weak and don't see a strong connection between political developments and investment fundamentals.

Benjamin Graham - the father of value investing - considered investing in something you don't understand and can't analyse to be speculation. We agree. As long-term investors, politics doesn't play much of a role in how we view our portfolios. We want to know the range of possible outcomes and position accordingly, but we must resist speculating.

Sentiment doesn't equal fact

Much has already been said about the recent Brexit developments — before, during, and after each negotiation point. Even professional investors spilled a lot of ink or pixels exploring the possible outcomes and implications. We don't always write about these events as we don't want investors jumping at shadows. It's not that we ignore politics or don't want to share our thoughts; it's that we believe doing so may send the wrong message to investors.

We are long-term investors rooted in fundamental facts. Political events rarely fit into that equation, primarily for two reasons: their short-term nature and their unpredictability. For instance, whether Theresa May is successful in her vision for Brexit or it results in further Cabinet resignations still carries a lot of unknowns.

It makes great news fodder, but the clearest effects on markets tend to be short-lived. Also, it's hard enough to predict political outcomes. But to be useful, an investor's prediction must not only accurately capture an outcome but all that follows, too - how the market responds, and how policies or other changes stemming from the event may one day affect investment fundamentals. Let's take each point in turn.

Dangerous predictions

It often seems that campaign promises are made to be broken. We might talk a long time about the imbalance between the ease with which a politician can talk about solutions and the reality that political deals can be hard to strike and are often loaded with compromise. This is democracy, and we believe we should embrace it, while maintaining a healthy scepticism about the execution of what is said.

Soapboxes aside, the point is that it's hard to connect pre-event analysis to post-event reality. And if the connection here is tenuous at best, then we might say we're operating in what statisticians call a "low validity environment". Plainly put, it's what Mike Tyson was referring to when he said something1 like, "Everybody has a plan until they get punched in the face."

So, it seems predictions for the Brexit deadline and beyond are bravely asserted, but once pundits—or investors—get hit in the face with the political change, they often need to reanalyse and reconstruct their theories. The effect is that political outcomes drive short-term, knee-jerk reactions in markets. Recall the predictions, even by at least one investment bank's researcher, that a Trump win in the 2016 US election would cause calamity in markets—which it did globally overnight after the election, only to give way to considerable market gains since.

At Morningstar Investment Management, we don't make investment decisions based on political events because we don't see a connection to fundamentals. Our process rests on four pillars: understanding how a security's or market's price compares to its underlying cash flows, both in relation to its own history and to its peers; studying fundamental risk; and observing contrarian indicators, or evidence that an investment is unloved (or overly loved) by the market. Political outcomes like Brexit don't tend to affect any of these four pillars in any reliable, foreseeable way.

Refocus on potential opportunities

As long-term investors, we encourage investors to reconsider how they view Brexit. The following points may help:

  • Don’t react immediately to news, however certain or material.
  • Don't try to anticipate market reaction—markets move faster than any investor and price-in anything fundamental immediately.
  • Wait out the noise and wait for real change with policies or earnings implications.
  • Be prepared to act against the herd; what is assumed as consensus does not always become reality.

Volatility can be your friend by offering quality assets at cheaper prices than previously available.

At most times, we try to emulate great value investors, like Benjamin Graham or Warren Buffett, who would caution against investing in something you don't understand. Political events like Brexit can't be understood because of the indirect and tenuous connection it has on investment fundamentals. We therefore believe that when investors depart from long-term, fundamentally sound investment analysis, they can drift dangerously into speculation.

 

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Dan Kemp is chief investment officer, EMEA, Morningstar Investment Management.

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

is chief investment officer, Morningstar Investment Management EMEA.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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