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18th July 2016 10:34

Lee Wild from interactive investor

The FTSE 100 may have taken off, but a sell-off elsewhere looks overdone. Lee Wild reveals where this expert thinks the big opportunities are.

Let's put speculation that Brexit will not happen to one side and assume it goes ahead in some way shape or form. Negotiations will inevitably be lengthy and messy, and predicting the precise outcome impossible. But a recession? Yes, maybe, but nothing deep or prolonged, yet many stocks are still pricing in a worse-case scenario.

"The current environment is very different to that which characterised the three full-blown recessions since the mid-1970s in the UK, all of which shared a commonality of prohibitively expensive (or the effective absence of) credit supply to the economy," writes Exane BNP Parbas Monday.

"While it should be expected that banks adopt a more cautious stance on higher-risk lending, for instance, whatever else awaits the current environment, characterised by a well-capitalised banking sector, Bank of England policy easing, and record low interest rates does not belong on the same page."

Post-Brexit confusion has thrown up plenty of portfolio opportunities, among them distressed UK domestic demand plays, oversold cyclicals and financials. Others, meanwhile - stand up defensives - have overshot on the upside in the past few weeks.

What to trade

Exane reckons investors should go long UK domestics, long cheap cyclicals and financials, and short "expensive" defensives.

That first trade targets stocks trading on multiples either lower than, or near to lows seen in the 2011/12 stress because of their heavy exposure to UK domestic demand. They have underperformed the FTSE 250 by at least 15% since the EU referendum.

We're seeing a lot of the same names crop up in these screens run by the analysts, particularly Dixons Carphone, Marshalls and easyJet.

Bank of England governor Mark Carney has promised to do all he can to protect the UK economy from a post-Brexit meltdown. Expect interest rate cuts and further quantitative easing if things get bad. But, of course, he's not the only fan of monetary easing and fiscal stimulus, and there's more here to come from Japan.

That means ample liquidity, but could also generative far more optimism than currently factored into forecasts. PMIs currently tipped to fall well below 50, signalling contraction.

"In this context, we suggest investors take another look at cheap cyclicals and financials that could benefit from a reflation trade," urges Exane. "We select underperforming cyclicals trading on trough EV/EBIT [enterprise value/operating profit] multiples and financials on trough P/B [price/book] multiples".

Obviously, many of the bombed-out UK play mentioned above - Grafton, Travis Perkins, Hays, Dixons and easyJet among them - also appear amidst the cheap cyclicals. Howden Joinery, Hays and William Hill also get a mention from the broker, which thinks Barclays looks cheap, too.

On the sell side, many defensive stocks now look over-priced. Look at Diageo, GlaxoSmithKline, Imperial Brands, Unilever and Reckitt Benckiser. However, I suspect investors may have trouble parting with these high-yielding safe-havens right now.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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