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Don’t Panic: “The Official Hitchhikers Guide to the Brexit”
24 Jun 2016
Neither campaign would deny that a ‘Brexit’ was by far the worst outcome for investment markets in the short term. The most sure-fire way to lose in this situation is to panic. It is important that we all take time to reflect why we invested and what we invested for and see how this will be truly affected. We would like to also take this opportunity that it is NOT the result we would have predicted and in fact in a poll of the office, not the outcome that would have arisen if we were the only voters. But we weren’t. So now it is important that one of the largest Independent Financial Services firms in the region gets on with the job in hand, as you would expect us to do. The referendum battlefield was won and lost using pathos – emotional persuasion, now it is time for us to use logos – logic and reason.
At Strategic Solutions, we are long term investors. So are our clients. That is the most important thing to focus on.
Much will be written over the next few days and weeks about the impact of today’s referendum. Doubtless there will be emotional voices of doom and of joy but as ever with these things, the reality will likely lay somewhere in between as the dust settles. Although we do not generally comment on short term market moves, we know from many years of watching markets, that reacting at times of discomfort is invariably the wrong course of action so we thought it was worth giving an update on our current thoughts:
The UK economic outlook is likely to be severely affected by the decision to leave the EU. The economy sagged under the uncertainty of the referendum itself, with deferral of investment activity. The decision to leave the EU looks likely to make much of this deferral longer term. We expect subdued investment and foreign direct investment into the UK to weigh on activity. Rising uncertainty for employment is likely to renew pressure on households. We expect UK GDP growth to slow significantly our best estimate is that growth will slow from an annualised pace of 1.6% to around 0.5% in the second half of 2016, with zero growth achieved in 2017. We can expect inflation to jump to 3% or 4% by the second half of 2017, as a direct result of the decline in sterling.
On the back of a recession, expectations for interest rate hikes by the Bank of England are firmly off the table. Instead, the focus will now switch to how the Bank can support the economy through this period of adjustment. We therefore expect the Bank of England (BoE) to look through the rise in ‘imported’ inflation. Policy will surely be looser than it would have been under Bremain. We also expect BoE will think hard before intervening to defend the pound. The fall so far today has been dramatic, by any standard, with the pound at one point falling to its lowest level against the dollar in over 30 years. Arguably, a double digit decline in the currency is not an over-reaction to a policy change of this magnitude. Governor Carney spoke this morning to reassure financial markets. He stated that the Bank stood ready to provide liquidity support in sterling and foreign exchange, if necessary. He reiterated that the commercial banking system was significantly more resilient and better capitalised than in the past. That is reassuring.
We always forecast that Brexit would consider an easing in monetary policy. We estimate two 0.25% rate cuts starting later this year and the likelihood of £50bn QE in 2017
The fallout from the referendum result is going to cause a considerable increase in volatility, at least over the short term. But despite this, the sun will still rise, companies will still trade and consumers will still spend. We believe that the short term volatility unleashed by the referendum result will ultimately create opportunities for our portfolios to take advantage of. Our job over the coming months is to make sure that when we are presented with attractive entry prices for high quality assets, we take advantage of them.
We have however heard that several fund management groups may restrict redemption volumes to enable them to manage their liquidity risks. Any decision by a fund management group is outside of our control and we do not expect to be given any notice
Further afield, growth in the Eurozone will be dented, possibly strengthening the case for the European Central Bank to expand its quantitative easing – bond purchases – maybe as soon as this autumn. If there is a prolonged decline in global market confidence, the US central bank could find it more difficult to move forward with higher interest rates in the second half of 2017. Central banks in countries with "safe haven" currencies, notably the Japanese yen and the Swiss franc, may also come under pressure to ease policy to prevent these currencies rising a lot further.
In the longer term, it is our view that the trajectory of the UK economy, and more importantly the world economy, will not be influenced significantly by today’s outcome. Consequently, the portfolio strategy will not significantly change. It was designed for a challenging world, characterised by low growth, deflation, debt problems, weak productivity and troubling demographics. Despite these headwinds, we remain confident that the portfolio will deliver the returns we have targeted over the three-to-five year time horizon that we continue to focus on.
We believe that new trading agreements will be reached; and in our view, the UK’s fantastic companies will be able to compete. On the other hand, much is now uncertain, and markets dislike uncertainty. But as long-term investors, we will regard sharp falls as buying opportunities – selectively.
The lesson here is that equities are long-duration assets, much more volatile in the short than the long term. Their true value is determined not by the profits companies will make (or not) this year or next, but in the long term.
There are significant consequences. But right now we do not think the Brexit shock poses an immediate long term threat to the global recovery. Over time, we would expect this reality to be reflected in asset markets outside the UK, particularly in the US, where the stock market has reacted sharply to a result which would be expected to have only modest direct consequences for the US economy. However, it could take some time before the dust settles and investors should expect plenty of volatility, as UK policymakers and the wider world come to grips with the consequences of this historic vote.
The UK economy will of course ‘survive', given its entrepreneurial flair, increasing focus on non-EU trade, and likely policy accommodation by the Bank of England and UK Treasury. However, getting to the next stage could be a long, drawn-out ‘cans of worms, leaving uncertainty for UK assets and markets. The extent of this damage now rests on the details of the exit.
The most sure-fire way to lose in this situation is to panic. Please contact your adviser if you need more details or reassurance.