Key points

  • The result serves as a barometer of wider popular disaffection with political leaders.
  • Faced with extraordinary uncertainty and the associated rise in market risk aversion, the scope for further central-bank policy easing has increased.
  • We have argued for some time that a combination of factors has warranted more cautious portfolio positioning, and the uncertainty of the immediate consequences of a vote for ‘Leave’ compounds existing challenges.
  • The scope for capital to stay away from the UK leaves sterling vulnerable to further falls in the medium term.
  • The headwinds created by economies’ collective debt burden and ageing demographics, and by disruption from rapid technological change, imply that consistency of cash flow generation, strength of balance sheets and pricing power, and flexible cost bases are likely to remain positive investment attributes. To our mind, the UK’s vote to leave the EU merely adds to the importance of these characteristics in investment selection.

Full analysis

Uncertainty, which is detested by financial-market participants, is the clearest immediate feature of this outcome as the UK awaits discovery of what the vote actually means. Meanwhile, UK politics will be in turmoil, with the potential for a general election and a second referendum on Scottish independence in the not too distant future. 

The ramifications of the vote are likely to be significant on a global basis, given that it serves as a barometer of wider popular disaffection with political leaders. The immediate test will follow this weekend, with the general election in Spain, and few will ignore the potential read across to the US presidential poll.

Faced with extraordinary uncertainty and the associated rise in market risk aversion, the scope for further central-bank policy easing has increased; if there had remained any prospect of a rate increase in the US this summer, this has clearly evaporated in the aftermath of the referendum. Beyond an immediate interest-rate cut from the Bank of England, the Bank of Japan stands out as a likely candidate for intervention given its discomfort with the yen even before the rally that has followed the UK vote. Equally, it seems unlikely that any politician will be able to ignore the indication of popular discontent. Looser fiscal policy, which can be wrapped into the idea of a ‘people’s QE’, seems inevitable.

While the actual process by which the UK will leave the EU will be prolonged, market volatility is likely to be elevated in the immediate future. This is not just because of events in the UK, as the threat of the UK leaving the EU has been only one of the risks facing the global investment outlook.

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We have argued that a combination of factors has warranted more cautious portfolio positioning, namely high asset valuations, a challenged outlook for corporate profits, and increasing evidence that ‘unconventional’ monetary policies do nothing more than provide a short-term sugar rush to economies – and contribute to social division. The uncertainty of the immediate consequences of a vote for ‘Leave’ compounds existing challenges, while the likelihood of policy intervention means that there is likely to be considerable scope for two-way market swings.

For the UK, clearly the hope that the referendum would resolve the long-standing division within the Conservative Party has failed. It is difficult to envisage the Party being able to reunite quickly after the vitriol of the recent debate. With the Scottish electorate voting strongly in favour of ‘Remain’, the prospect of a second independence referendum there looms large.  This uncertainty is likely to continue to drag on UK economic activity as decisions are postponed until the future offers greater certainty.

Having rallied before the count, as expectations mounted that the UK would vote to remain in the EU, the immediate reaction of sterling has been to plunge towards $1.35. With UK policy likely to be eased and activity likely to remain weaker, there seems little reason to anticipate a rapid rebound beyond near-term volatility. The scope for capital to stay away from the UK leaves sterling vulnerable to further falls in the medium term. Gilt yields are likely to remain lower as the prospect of policy support from the Bank of England and the probability that sterling funds seek a safe haven serve to cap risks of a foreign buying ‘strike’.

The uncertainty caused by the UK referendum result adds another layer of challenge to the hope for a sustainable recovery in activity, which has to date eluded policymakers. This has been an issue that has not only impacted the UK, but also the US, Japan and the eurozone. The shift to seemingly ever-lower bond yields was already being corroborated by central bankers’ repeated downward revisions to growth and interest-rate forecasts. The comments from Janet Yellen, chair of the Federal Reserve, in Congress recently were particularly notable. They suggested a significant shift in her outlook – from ‘when’ the Federal Reserve can raise rates, to ‘whether’.

Even before the clouding of the outlook that has followed the vote to leave, the absence of a miracle cure for the overhang of capacity that characterises large swathes of our economies made it likely that investors would make a more sober assessment of the investment characteristics best suited to this backdrop. The headwinds created by our collective debt burden and ageing demographics, and by the disruption from rapid technological change, imply that consistency of cash flow generation, strength of balance sheets and pricing power, and flexible cost bases are likely to remain positive investment attributes. To our mind, the UK’s vote to leave the EU merely adds to the importance of these characteristics in investment selection.

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This is a financial promotion. The opinions expressed in this document are those of Newton and should not be construed as investment advice or any other advice and are subject to change. This document is for information purposes only and does not constitute an offer or solicitation to invest.

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