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BREXIT – Where to from here?

Despite most financial commentators’ predictions, the unthinkable has happened.  Below is a brief overview of how we see things.

  • Whilst Friday's outcome undoubtedly surprised markets, the scale of the initial reaction is consistent with expectations. Markets are functioning at this point and we expect central banks and politicians to respond in a considered way

  • The wider geopolitical implications for the UK and Europe are of great significance and need monitoring. However, it is important to keep this event in context - this is far from the global financial crisis of 2008

  • Now is a time for investors to concentrate on long-term fundamentals and we remain well placed to do this. Volatility will give rise to some significant investment opportunities
  • We remain focused on meeting client investment goals and do not expect any significant disruption to how we manage portfolios

Given that over 78% of FTSE 100 revenues are derived overseas, as well as the incremental effect from weaker sterling, it seems unlikely that there will be a significant earnings hit, despite the expectations that the UK economy will suffer post the Brexit result.  We have seen the UK mid-cap FTSE 250 underperform the FTSE 100 by around 3% so far this year, so mid-cap domestically-focused businesses are already partially factoring in the anticipated weaker UK economy and good fund managers will capitalise on this.  Friday’s result is likely to continue that trend but long term investors should be responsive to excessive price moves driven by poor liquidity.  Somewhat surprisingly,  after a sharp opening correction the FTSE 100 Index closed down only around 3% at the end of Monday’s trading but we will undoubtedly see continued volatility, as we are now experiencing not only economic uncertainty but also political uncertainty in the UK as a result of David Cameron’s resignation announcement.  As we know, stock markets loathe uncertainty but market reaction in the FTSE this morning has been relatively subdued, partly as a result of George Osborne’s statement.  Expect more QE from the Chancellor, if required.

European markets are perhaps a different story. The UK is the second largest EU economy, accounting for 16% of GDP, so the withdrawal will be very significant for the remaining countries. Subject to the political and monetary policy response, many investors will question the sustainability of the remaining EU structure. Peripheral countries may experience a widening of their credit spreads as the market fears more EU fragmentation. At some point however, there will be a compelling value opportunity for European equities, induced by the market rapidly pricing in a worst case scenario driven by Brexit. Quite often in times of market stress correlations are very high with indiscriminate selling and should this happen, global companies with exposures outside of Europe may well provide the most upside potential.  We will therefore maintain exposure to European equities of between 8% to 10% in most client portfolios.

A quote today from former Bank of England governor, Mervyn King, perhaps provides some degree of perspective:

"Markets move up, markets move down. We don't yet know where they will find their level and the whole aspect of volatility is that there is a trial and error process going on before markets discover what the right level of stock markets and exchange rates actually are. What we need is a bit of calm now, there is no reason for any of us to panic."

This entry was posted on June 27, 2016