The result of the referendum was a huge surprise to just about everyone, even for the politicians who have been campaigning for it. However, the situation is what it is, so unless there is a second referendum, as investors we have to face up to the reality of a possible world that is changing.
Here is my advice on how to deal with the changes that may or may not actually happen
- The reality for now is that nothing will change immediately as the UK remains a member of the EU until it triggers the Article 50 and the formal exit process begins. Even once the process start the UK will remain a member for at least the next two years.
- For sure the UK and wider Europe will face a period of uncertainty, even though trade agreements will be renegotiated. Without doubt uncertainty is likely to result in some level of reduced confidence within the UK economy. As a consequence growth could be lower in the next two years than previously forecast – That said George Osborne has never been all that accurate with his economic predictions.
- The UK is faces political uncertainty in that a new Prime Minister will be elected and initial forecasts predict that this will be completed by September this year. What was not predicted was the in-fighting within the about Labour party and as I write this article Jeremy Corbyn may indeed lose his position as leader of the opposition. Only time will tell how this pans out.
- The result of the referendum is without doubt the biggest shock to the EU project since it began in 1956. The UK is the second largest economy in Europe and also the most free and open market. The UK’s presence in the EU will be missed and its exit could trigger other countries considering their membership as well. If other countries do leave it is likely to happen over a long period of time.
- Contrary to many people’s reactions, we do not believe Brexit is as big a global event. The UK economy is represents less than 4% of global GDP so even a fall in UK growth is not likely to have a material impact globally. To put it in perspective China, growing at 6% to 7% per year, is adding an economy the size of the UK to the global economy every four to five years. UK banks are also very well capitalised and have much greater capacity to absorb shocks than during the global financial crisis of 2008. Any implications for the remainder of the EU are uncertain but they will play out only over a very long period.
- We expected UK interest rates to stay at current levels for the next year at least and the same applies in Europe. It is possible that the Bank of England could cut rates from the current levels of 0.5% further into the future, although the economic impact is unclear.
- Even though the result was not predicted, many economic experts felt the biggest risk for investors in the event of Brexit was pound. The concerns surrounded uncertainty surrounding over future trade arrangements and foreign investment flows. The immediate falls in the pound, if sustained, would help the UK, as long as they did not feed through into higher inflation expectations. There is likelihood that the pound will now be weaker against the dollar in the medium term, but less so versus the euro given the damage to the EU from Brexit.
- Government bond yields in the UK have fallen in the immediate post-Brexit market reaction. The possibility of lower or slower growth in the UK in the next year or two, together with the possibility of near-zero short-term, are likely to offset concerns that the weakness of the pound may lead to higher inflation and we expect bond yields to stay low.
- Equities have been sold off to a degree which we believe is irrational and unjustified. We see no reason why, US equities or corporate bonds generally should fall as sharply as we have seen and we do not believe Brexit increases credit and default risk, especially outside the UK, and the falls to date are creating opportunities on a longer-term view. In the case of UK equities they are firmly underpinned by reasonable valuations, a good dividend yield and by the fact FTSE 100 companies in aggregate derive more than 75% of their sales and profits from outside the UK.
- Our view is that the UK will thrive and prosper whether in or out of the EU and that the current market volatility is not necessarily rational. Once we are through the short-term period of adjustment and uncertainty, which the markets are pricing in very quickly, we are confident the UK will continue to benefit from its structural strengths, open and dynamic economy and flexible labour market. The UK remains open for business and its inherent and well-established attractions means it will remain a destination for substantial inward investment.
- Without doubt the result of the referendum was a huge event and we are all likely to remember where we were on “the day”. Of course the circumstances create short-term concerns and have raised many questions as we now embark on a new era. This undoubtedly raises volatility in financial markets at least in the short term, especially in the UK and Europe. The UK has a strong, open and resilient economy, however, and markets will settle down to the new reality after a short period of adjustment. We believe now is the time for a considered, measured approach, maintaining broad diversification in portfolios and using short-term volatility as an opportunity to buy assets at attractive valuations.
This article does not provide specific advice and you should always seek professional advice from a qualified adviser before making any decisions.
Contact Martin Dodd on 01902 742221 or email him at [email protected] if you would like talk about money issues.
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