As investors, it is our duty to take a step back and look for opportunity where others see fear. Brexit has caused concern amongst financial markets, both before and after the referendum. Unanswered questions about the strength of the pound, trade deals that the UK will have to negotiate with other nations and how we will continue to trade with the EU (because we have to, neither party can afford to cease trading) are worrying investors, and naturally, we can assume lower stock prices in this environment.
Markets don't like uncertainties, and Brexit most certainly is one. On Friday last week, British Prime Minister David Cameron announced his resignation, which may not come as a huge surprise to some, but poor timing and yet further unanswered questions regarding succession have caused stocks like Lloyd's Banking Group (NYSE:LYG) to lose 20% in a single session. An article written by Renaissance Research explains how this unique buying opportunity can be used to acquire such stocks with a great long-term future.
- Who will be the Prime Minister to lead Britain's independence?
- How many jobs will be lost as a result of the referendum?
- Will the UK fall into recession like many experts predict?
- How will we continue to trade with the EU and other nations? What if they reject our trade agreement or impose large tariffs?
- Will many of the large firms with European Headquarters in London remain in a country outside of the EU? What happens to all the people employed by them, and the effects of the subsequent loss in GDP?
- What if other nations want out? What if Scotland leaves?
- How will we spend the membership fees, and compensate for the loss in EU subsidiaries? What if all the financial gain is eliminated by a recession and further borrowing?
The list goes on and on, and only time can give an honest answer. The self-induced headwinds that now face the UK, and European economies are now real, and the true extent of which will only be apparent in the months and years that follow the referendum. If history is anything to go by, Friday's sell-off is not likely to be a one-off event.
We may see a bounce this week, similar to the end of Friday's session, but this is likely to be short sellers taking a profit, rather than a meaningful bottom. Many of the unanswered questions will still be a mystery at the end of the year, and it is therefore very difficult to predict when the Brexit sell off will terminate.
But does that mean we should refrain from buying high-quality stocks if Mr. Market offers us a discount? Will the growth of Starbucks (NASDAQ:SBUX) or Facebook (NASDAQ:FB) really be compromised because the UK is no longer a member of the European Union? Will Wells Fargo (NYSE:WFC) and Johnson & Johnson (NYSE:JNJ) struggle to continue their decades of dividend growth? I don't think so, not in the long term.
What should we look out for?
The financials in particular have taken a big hit, with LYG being the obvious example. If unemployment rises, wages and house prices fall, along with a likely slowing of population growth, the future of the UK's largest mortgage lender is no longer quite as bright as it once was. But does that really warrant a 20% fall in the price of a stock that was already fairly cheap?
Yes there are concerns, but falling house prices enables more people to afford houses, especially first time buyers, and although the pound may be weaker, we still have to deposit our wages and pay our bills from somewhere. If money never leaves the UK, the value of the pound relative to other currencies is completely irrelevant, so why the huge sell off? Will the majority of Lloyd's business really change as a result of the referendum? I don't think so, certainly not if your timescale is measured in years.
Of course, the other thing to look out for is a discounted stock that has little or no relevance to Britain's membership with the EU. Earlier I mentioned Facebook and Starbucks as examples of growing companies that are not going to see significant change as a result of the referendum.
Wells Fargo is an extremely well run bank that does the majority of its business in the United States with US citizens, but has suffered a near 5% hit because of something that is almost meaningless to the company's bottom line going forward, which is why on Friday I took the opportunity to add to my position.
Facebook and Starbucks are just 2 examples of stocks that I think will be relatively immune to the adverse effects of Britain leaving the EU. We will not stop using social media or buying our morning coffee because the UK has left the EU, and neither will we stop using banks like Lloyd's to pay our utility bills and deposit our wages every month.
It is important to take a step back and consider the risks of Brexit to each individual stock when working out whether cheap prices are buying opportunities, or a real warning to stay away. As explained in Renaissance's article, Lloyd's may be a bargain, but Royal Bank of Scotland (NYSE:RBS) is in a terrible situation and should be avoided like the plague.
I very much doubt that Friday was the end of the selling. It will take weeks for the investment community to digest what has happened, and in that time, there will likely be a steady downward trend in stock prices. Calling the bottom is a fool's game, because the likelihood is that most investors will miss the opportunity, so be vigilant, decisive, but not greedy. There will be some referendum-induced bargains in the coming weeks, so don't be afraid to pull the trigger on a high quality name at a high quality price.
Disclosure: I am/we are long WFC, LYG.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.