Market Bulletin Hero

The Votes Are In…But What Does That Mean?

24 Jun 2016

Chris Darbyshire, Chief Investment Officer

Three months of tough campaigning has resulted in a vote to leave the EU. But what happens next? Markets reacted badly to the outcome, but how did portfolios perform? We dig into some of the reactions and returns.

Three months of hard, rancorous campaigning are now over and the British public has voted for Britain to leave the European Union (EU). Investors are now in uncharted territory. The opinion polls leading up to the vote were neck-and-neck, but financial markets and book makers had lately swung to expecting a high probability of a Remain outcome: betting markets priced in a 90% probability of Remain the day before the vote. We do not yet know why, but they were wrong, and the surprise is a major shock to financial markets.

A 52% mandate to Leave has been concentrated in England (ex. London) and Wales, whereas the Remain votes have largely come from Scotland and Northern Ireland. This creates urgent questions about the future of the ‘United’ Kingdom as a single entity.

As we expected, the Pound has proved to be the pressure point, with the value of Sterling falling significantly against almost all major currencies across the world. David Cameron has resigned but will only step down in October. This will trigger a leadership contest that will look to take place as soon as possible given a lack of leadership during the difficult transition period is undesirable. There are also whispers of some Conservatives lobbying for a second renegotiation with the EU, and perhaps a second referendum.

Also, as feared, UK stock markets have reacted poorly to the prospect of even more uncertainty for the foreseeable future. What we are seeing are attempts to price in the impact of some (or all) of the dire warnings given by businessmen, economists and politicians in the weeks leading up to the vote, with the downside exacerbated by the stock market rally in the past week.

European equities are, unsurprisingly, in a similarly negative spiral – markets have opened lower, down double digit levels in some cases. This is to be expected given that the UK’s departure has a bilateral impact, affecting the EU as much as the UK. The most pressing matter will be the political pressure that the remaining members face to reform their relationship with the rest of the EU bloc. There is popular support for similar referenda on EU membership in Germany, France and the Netherlands, and in the next 18 months there are elections of some kind in most of the rest of the EU nations.The most pressing matter will be the political pressure that the remaining members face to reform their relationship with the rest of the EU bloc.

While in a political sense the US and Asia are not directly impacted by this decision, the second-order economic effects are unlikely to be positive in the short term, and we have already begun to see a significant negative market reaction ahead of this turn of events. The Japanese market saw trading suspended following a fall of more than 7%. Since the crisis in 2008, global contagion has been the first assumption for international investors, who have tended to sell first and ask questions later. That sentiment is clearly playing out this morning.

The classic ‘safe haven’ financial assets - the Yen, the US Dollar, US Treasuries and gold - have all rallied sharply.

While our portfolios have not been immune to the negative market reaction, our exposure to US Dollars has proved sensible, substantially mitigating the impact on our investors’ portfolios, as have our holdings in US Treasuries, gold and other foreign currencies. This morning, while the votes were still being counted, we added more US Dollars to the portfolios. In this environment, we will continue to look to take actions most likely to preserve investors’ capital – although we are well aware that there are likely to be a few oversold opportunities around too.

Elsewhere, we are looking at the liquidity constraints and making sure that we don’t rush into making poor decisions.

So what do we now see playing out? The lack of precedent means that policymakers’ actions are very difficult to predict. We feel reasonably confident in saying that the Bank of England is likely to engage in some form of monetary stimulus to offset potential economic stress – a cut in interest rates to zero, perhaps coupled with a restart of the Quantitative Easing programme. The Bank will want to keep the cost of capital for businesses and personal loans as low as possible, and enable financial institutions to meet redemptions.

The question of the UK’s sovereign debt rating will undoubtedly rear its head. The UK lost its across-the-board AAA status in 2013, but there may be further speculation of downgrades. We are reasonably sanguine here - there is no real question of the UK not being able to meet its obligations. The larger issue for Gilt markets is that foreign investors may sell down their holdings in order to remove Sterling exposure from their portfolios. This could see a nasty situation over the next few weeks where equities, Gilts and Sterling all fall in value. As events unfold, we are likely to continue to rely on our foreign currency exposure to mitigate portfolio risk.

Chris Darbyshire
Chief Investment Officer

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The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.
The value of your investments and the income from them may go down as well as up, and you could get back less than you invested.

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