The impact of Brexit thus far has been generally positive for share prices. Following their initial fall in the immediate aftermath of the EU referendum on 23 June, shares have staged a major recovery. In fact, the FTSE 100 has risen by 9%, while the all-share index is up 7%. Can this level of performance really last?
The impact of Brexit on shares is likely to differ depending on a company's exposure to the UK economy. For stocks that have a large degree of international diversification, there's unlikely to be much difference in their underlying performance of the UK economy struggles.
Therefore, most of the FTSE 100's constituents are unlikely to be affected by any short-term challenges posed by Brexit. In fact, the index could rise in the short run if sterling weakens further and investors seek out stocks that are lower risk, larger and more stable to ride out what's likely to be an uncertain period.
Tough times ahead?
However, companies that are reliant on the UK for some or all of their earnings are likely to lag their more diversified peers. The UK economy is set to endure a more difficult period as higher inflation reduces disposable incomes in real terms. This could stifle consumer demand and cause sales for UK-focused companies to come under pressure. Since most smaller and medium-sized companies listed in Britain are UK-focused (or more likely to be than larger companies), the FTSE 250 and FTSE all-share indices could underperform the FTSE 100 over the coming months.
That's especially the case once Article 50 of The Lisbon Treaty is invoked. The negotiation process between the UK and the EU is unlikely to be a smooth one. Both sides could be stubborn in their demands and cause negotiations to progress at a slow and frustrating pace. This could put added pressure on the UK economy as investors become increasingly uncertain regarding its long-term prospects outside of the EU.
During such a period, mid-sized and smaller company share prices could fall, and even the FTSE 100 may struggle to make gains. That's because a seemingly unsuccessful negotiation period wouldn't be good news for the EU, for which the UK is a major trading partner. In turn, a weak EU could dampen global growth prospects and cause more investors to sell shares in favour of risk-off assets such as gold.
Of course, this may provide an excellent buying opportunity for long-term investors. The FTSE 100, FTSE 250 and FTSE all-share could fall in the coming months and so leave high quality stocks trading at discounted prices. Longer term, the UK and European economies are very likely to recover, since it's in both their interests to work out trading arrangements that allow both regions to prosper. As such, even if shares disappoint in the near term, they're likely to deliver excellent performance for those investors with a little patience.