The morning after - the reality of Brexit
Both we and financial markets were surprised by the result of yesterday’s referendum. “Remain” had regained a lead in the opinion polls as the vote approached, so stock markets and sterling had been rising on the assumption the UK would remain in the EU. We thought the electorate would support ongoing membership of the EU because the UK has traditionally been an internationally-engaged nation; we also expected worries over the economic impact of Brexit to challenge the “Leave” campaign, but it seems concerns over immigration were a more powerful motivating force for the nation at large.
We set out our expectations for the consequences of the vote in our note “If we stay or if we go”, which we published on Monday 20 June 2016; a link to the note is available here. We observed Brexit could lead to slower economic growth in the UK in the short term, as uncertainty could impact corporate and consumer confidence; we expected the anticipation of weaker economic activity to cause sterling and share prices to decline, but safe haven assets, such as gilts, to rise. However, we thought the longer term implications of Brexit were not as concerning, since economic weakness could be addressed by a stimulus package from the Bank of England. We also noted lower sterling would enhance the value of overseas profits earned by UK listed companies, thereby restraining the downside for UK share prices, and we expressed the view that the UK economy should be able to adjust to its new circumstances as it is flexible and adaptable.
Financial markets have responded to Brexit in the manner we expected thus far, but by a smaller magnitude than some had feared. At the time of writing, the FTSE 100 index has declined by c.2.5% and is trading above 6,180; this is higher than 2016’s low of 5,537 which was reached on 11 February, when fears over the Chinese economy were at their maximum. Today, sterling has declined by 8% against the US dollar and 5.5% against the euro, and 10-year gilt yields have declined to a new low of 1.06%; a cheaper currency and lower government borrowing costs, if sustained, should support the UK economy in due course.
While we retain a relatively sanguine view of the economic consequences of Brexit, the political ramifications could yet be profound. In the UK, parties will need to reflect on the message sent by the electorate and adjust their priorities and policies. Another Scottish independence referendum may be sought and a break-up of the Union is plausible. Across the rest of Europe, Brexit may encourage radical voting in national elections and we could see further structural change in the EU. We will be alert to the risk that political upheaval unsettles economic prospects.
We noted before the vote that diversification across asset classes and currencies is an important means of protecting portfolios at times of uncertainty. A balance of holdings with different risk profiles and geographic exposures can also provide the opportunity for portfolio rebalancing after extreme price moves; currently, however, we believe that markets have responded to Brexit in a sober manner and our recommended positioning remains appropriate for long term investors. We will keep this under review and advocate adjustments to portfolios, if necessary.
To discuss this note, or any other matter, please contact Nick Fletcher on 0203 696 6801, or any member of the London Wall Partners investment team on 020 3696 6805.
The information, data, analyses, and opinions contained herein are provided solely for informational purposes and may not be copied or redistributed; neither do they constitute investment advice offered by London Wall Partners and therefore are not an offer to buy or sell any security. London Wall Partners expressly disclaims any responsibility for trading decisions, damages or other losses resulting from any use of the information herein. Investments fluctuate in value and may fall as well as rise and investors may not get back the value of their original investment. Past performance of financial markets should not be used as a guide to future performance.