How will the Brexit outcome impact housebuilder shares?
With the Brexit process reaching its final stages, how could each potential outcome impact valuations within the housebuilding sector?
The housing sector has been one of the areas of particular note that has been affected throughout the Brexit process, with demand, supply, prices and overall transactions shaken up in the wake of the 2016 referendum. It has not been a straight path for the industry, with nuances found throughout regions, and shifting trends in confidence brings periods of strength and weakness. One thing is for sure, the market has slowed across the country, with house price growth slowing to a half as we approach the end of the Brexit process (probably not a coincidence).
For the housebuilders this means lower margins, raising the amount they must build to even remain flat. For now, this is not a huge problem for the industry, as we are yet to see any major declines in house prices.
Construction PMI highlighting path for industry
The construction purchasing managers index (PMI) enjoyed a relatively positive period in the wake of the 2016 referendum, with readings rising all the way up to the 56 region. However, that trend has reversed sharply, with the past year seeing substantial downside for the sector, where much of 2019 has seen the industry contract (sub-50). The chart below highlights how movements in that PMI survey typically go hand in hand with the price action for some of the major housebuilders.
With that in mind, the PMI will also tell us a lot about where the particular area of weakness are found for the sector. Firstly, the latest construction PMI survey saw new orders fall at the fastest pace for over ten years, dampening demand in an environment of huge uncertainty. That is further reflected by the fourth consecutive month of downside for construction output, with that fall in demand no doubt impacting activity.
Finally, we have seen business optimism slide to the lowest level since 2008, underpinning the drop in demand and in turn hurting construction output. With that in mind, any outcome from Brexit should be followed for how is changes business confidence given the impact that can have upon demand and output. Interestingly, it is worth noting that while we have seen a sharp deterioration in the sector as a whole, the PMI survey alludes to a very different pathway for residential housing over commercial.
How to trade housebuilders in a no-deal Brexit
There are few that presume the housing sector would fare well in response to a no-deal Brexit, with KPMG recently claiming that house prices would fall between 5.4% and 7.5% throughout the UK. However, they have also said that a particularly strong reaction could see a decline of 10%-20%.
That would obviously hugely hurt margins for the housebuilders, instead likely pushing them towards build-to-rent until the market recovers. One benefit is that we would likely see lower rates in the event of a no-deal Brexit scenario, making mortgage payments relatively more affordable.
However, for the most part we would likely see significant disruption to the economy on the whole, and while some people could lose their jobs and delay any plans to buy a house, we would also see a huge amount of hesitancy for many as they wait to see how things resolve when the dust settles.
Remember the importance of business confidence for the sector. Well business confidence would likely be rock bottom, with that ensuring that demand wanes further on the commercial side. As such, with house prices hurting margins, and both business and consumer confidence at rock bottom, the sector would be hit hard for the months that follow the decision.
The length of time the UK would need to stabilise remains to be seen, but there is likely to be a great deal of hesitancy when it comes to investing large sums of money into a weakening housing market.
How to trade the housebuilders in a soft Brexit
A soft Brexit would certainly allay many of the fears associated with a no-deal Brexit. The specifics of such a deal would play a significant role in determining how much of a shock it will be for the economy, with a likely rally in the pound making it difficult for exporters who would also likely have worse terms of trade to content with. There is no doubt that the economy would still have a substantial amount of instability, yet the ability to avoid a no-deal Brexit would certainly raise confidence that it will work out for the better. With that in mind, the housing sector would be unlikely to suffer substantial losses, with the prices continuing to remain somewhat flat until we see signs of improvement in the economy.
How to trade the housebuilders in a no-Brexit
A decision to reverse the original referendum would almost certainly provide a huge boost to the sector, eradicating many of the fears over what Brexit could do to the economy. It is worthwhile that such a move could bring huge upside for the pound, with the pound having suffered huge losses against the likes of the euro (16%) and dollar since June 2016 (17%). That shift would no doubt erode international demand which has been rising in the wake of recent GBP losses.
While there is a good chance we could see interest rates rise in the wake of such a decision, the sharp rise in sterling would likely drive inflation downward in a move that would likely tie the hands of the Bank of England. Despite the possibility of easing demand from abroad and slightly higher interest rates, the domestic picture would likely ramp up hugely, with consumer and business confidence driving an increase in transaction and pushing prices higher once again.
Brexit market scenarios based on IG technical analysis
|No-deal Brexit||EU and parliament approve deal||No Brexit|
|Housebuilders||Expected to see sharp losses in case of no-deal, with detrimental impact on UK economy hurting demand until things settle.||Deal would ease fears of a sharp economic slowdown, ramping up confidence and likely pushing the housebuilders significantly higher. Brexit still holds uncertainties though, so upside would be relative to type of deal struck||A reversal of the vote via a 2nd referendum would amplify the upside seen through a Brexit deal, with the sector driving sharply higher|
|Financials||Banks to suffer, as economic shock dents confidence and lessens demand for loans. Likely lower rates also hurts margins||Sector likely to gain ground, particularly those domestically geared UK listed banks. Mortgage and business loan revenues likely to jump, while BoE outlook would point towards higher rates and thus improved banking margins||Sharp gains likely for the sector, with economic activity to ramp up given a rise in business and consumer confidence. A strengthening pound would ensure that domestic banks outperform those with high foreign earnings.|
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