by Tom Stevenson, Investment Commentator at Fidelity International
June 2016
The political, economic and market shocks triggered by the decision to leave the EU are all significant but of differing magnitude and duration. Of the three, the political upheavals are likely to be the most important, long-lasting and unpredictable. The economic tremors may persist but will most likely be regionally contained. The surprisingly sanguine reaction of UK equities on Friday suggests, counter-intuitively, that markets may be least affected.
After the rally in stock markets and the pound in the days running up to vote on June 23, it was only natural that investors should quickly re-calibrate expectations in the face of an extended period of uncertainty and economic slowdown. If anything, it was the rose-tinted wishful thinking ahead of the vote that was most shocking. I am reassured that, having blown away the recent froth, investors have paused for reflection.
It should come as no great surprise that European equity markets were hit harder than London in the immediate aftermath of the referendum. Britain’s situation is now in part a “known known”. Political risks on the continent, on the other hand, carry much greater uncertainty. It will take some time before the knock-on impact of Brexit on other Eurosceptic countries becomes clear.
From an economic perspective, we should expect lower growth in the UK and across Europe. That is clearly being discounted by equity markets. A moderate recession in the UK during the second half of 2016 and into next year looks probable. But Mark Carney has made it clear that the Bank of England stands ready to provide whatever stimulus becomes necessary.
The outlook for equity investors is more nuanced because prospects for company earnings, which ultimately drive the valuation of stock markets, are affected only at the margin. Companies are in many cases cash-rich and may be prepared to put that money to work. The fall in the pound will increase the competitiveness of UK exporters and overseas earners. Across the UK and Europe, businesses are much more international than their peers in the US or Asia. They may be less affected by a fall in domestic demand than some currently believe.
It’s worth remembering, too, that the repercussions of Britain’s decision will be a relatively slow burn. Unwinding a 40-year marriage will take considerable time and markets will have plenty of opportunity to get used to the changing landscape.
Mounting growth fears and subdued inflationary pressures have seen flows into the perceived havens of government bonds and gold.
It is human nature to retreat from danger. In more physically dangerous times that caution served us well. In today’s investment markets the greater risk may be found in excessive caution. The best days in the market often follow hot on the heels of the worst and missing just a few of these strong rallies can wreak havoc with long-term returns.
A political tsunami this may be and an economic shock. For investors things may turn out a bit better than feared.
