The result was a surprise to financial markets. Not surprisingly, equity markets are going to be quite weak today, with sterling assets more broadly quite weak.....
Mark Burgess, CIO EMEA and Global Head of Equities
The thing that markets hate most is uncertainty and with the prime minister resigning we’ve got political uncertainty thrown in on top of economic uncertainty and we don’t know what shape the UK economic arrangement with Europe is going to take. That is going to take quite some time to negotiate and we are going to have to negotiate any bilateral trade agreements with the rest of the world as well.
The real issue is about what it means for Europe. We’re likely to see calls for referendums in some of the other European countries and members of the Eurozone and the single currency, and I think the market is going to worry about the implications of that. We’re a single trading nation and clearly what the nature of our trading arrangements with rest of the world looks like is going to be uncertain and I think that will naturally slow activity. The uncertainty as well as what this means for Europe will also slow European equities unequivocally so this is a negative event for global GDP.
As for fund positioning, we’ve tried to be relatively neutral coming into this event, as it’s been very difficult to call. Equity portfolios are relatively defensively positioned, we’re quite underweight European financials and I think that’s where the pressure is going to be felt most. Our multi-asset portfolios have, again, been relatively defensively positioned and I think one of the great things about active management is that you can make these sorts of moves to take advantage of the right market movements. Clearly this is a day where absolute levels of markets are going to go down but I think relatively speaking our clients’ portfolios will be in an okay place.
We’ve been thinking about this for a long time, we are well positioned and we are going to be putting clients’ interests at the forefront of our minds. That market volatility is going to be quite heightened and that will provide us with opportunities to reshape portfolios as and when we see those opportunities offering value.
Richard Colwell, Head of UK Equities
Certainly in the short term the Leave vote will be a negative for both Sterling and the UK economy. In the longer term the consequences are much less clear. However, given the FTSE 100 is comprised of around 70% overseas earnings, the implications for the UK equity market may not be as great as some people fear.
There may be further opportunities in UK domestic stocks that have been sold off aggressively, in particular those stocks that were in the various ‘Brexit Baskets’ created by investment banks as they tried to exploit concerns about leaving the EU. Clearly, any exposure to overseas earnings is positive for investments as they are considered less exposed to the domestic economy and can benefit from a weaker sterling.
UK stocks (excluding financials) are also, to a degree, cushioned by the current market yield (at time of writing) of 3.95%, which is three times that of gilts and attractive in a global context. Indeed gilt yields are already at their lowest level since records began in 1729.
In the run up to the vote we did not make any major changes, in fact we continue to believe that there are more significant issues in the wider global market, such as policy fatigue, slowing global growth and heightened debt levels. In the short term our focus is on finding select opportunities to add to the portfolio where market sentiment is creating cheaper valuations.
Jim Cielinski, Global Head of Fixed Income
This outcome was very different to what the markets expected and certainly to that which was priced into the market as recently as yesterday. Consequently, the market reaction has been as immediate as it has been extreme.
Core bond markets have rallied sharply – as market yields have plunged to record lows in many developed markets. The benchmark 10-year US Treasury bond, for example, is lower in yield by around 20 basis points. This takes that yield to around 1.5%, the lowest in recent decades. German 10 year bonds have fallen by a similar amount to -0.10%. Peripheral European bond markets are being hit hard (Italian government bonds are wider in spread by around 30 basis points) and this should continue.
Within currencies, Sterling is around 9% weaker to the US Dollar (1.35), the weakest level since 1985 and the Euro is also weaker by around 3% (1.09). Meanwhile, the Yen has surged, strengthening to 101.5.
Credit markets are weaker. The widely watched Main index opened 26 basis points wider (around 25% wider of actual spread) and is at the widest level this year. Meanwhile, the Crossover index opened wider by 100 basis points (in percentage terms a similar amount). Financials, higher beta and cyclical credit have been harder hit with spreads around 30% wider over the last day. Commodity prices have been marked down with the exception of gold which has rallied.
What we expect to happen
These events foster an ‘immediacy’ bias, where the focus is on the next headline but this will be a long and drawn out period of uncertainty with a number of potential outcomes. The central case would be to expect the referendum outcome to be negative for global growth in general and for UK growth in particular. This lack of clarity will curtail investment and hiring and the prospect of a UK recession is certainly heightened. Meanwhile, the risk of a political vacuum has risen materially with the resignation of David Cameron. For Europe, the likelihood of further ‘copy-cat’ referenda has risen which will weigh on the currency and on peripheral European banks and companies. Markets have not factored in a scenario in which the EU unravels.
We believe that a number of central banks (Bank of England, European Central Bank and Bank of Japan) will need to ease policy. A weaker UK currency will produce higher inflation in the year ahead but this will ultimately prove to be transitory. Hence, although the decision to ease may be a close call - growth and stability concerns will dominate policy maker’s thinking.
Core government bond yields have plunged to record lows and will be supported as long as risk aversion prevails but further declines in yield should be limited. The price of so-called safe havens is now extreme.
Corporate issuers have become well-accustomed to operating in a low growth, weak revenue environment and for such companies it will be the extent of economic weakness that matters most. Our central case is for slow growth, no credit improvement but no sharp rise in defaults. Demand for income remains and this will continue to support spread markets as will a policy response (eg corporate bond purchases) that provides a ‘back stop’ and cushions losses in corporate bonds. As such, we remain modestly constructive of corporate credit.
Philip Dicken, Head of European Equities
Britain has voted on its European Union membership and has voted to Leave. This we know, but what we do not know is the result of the coming economic and political negotiations.
Over the next weeks and months, investors will be looking for clarity over, amongst many other things:
The new UK Prime Minister;
Changes to the UK’s relationship with the EU;
The EU’s response to the UK referendum including possible changes within the EU’s own governance;
The rise of populist / anti-EU parties in Europe (Five Star in Italy, Front National in France, Podemos in Spain etc).
Markets will respond to these challenges and to the changing economic environment, to movements in currencies and interest rate expectations. But this uncertainty will also result in volatility and this will give us, the active investors, real opportunities to add value. For example, which sectors will benefit from the weaker pound, which companies benefit from a continuing low interest rate environment and which stocks get oversold in any turmoil?
So far in 2016 we have managed our portfolios in a relatively defensive fashion. This has included a low exposure to banks, especially in the Eurozone, and a bias to companies which can grow in a low-growth world. This mainly bottom-up approach means that we are in a position of strength and allows us to continue our focus on long term alpha generation.