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Brexit – a Reality

28th June 2016

Brexit – a Reality

So last week, to the surprise of many, Britain voted to leave the EU. Whatever your opinion on the matter it seems that we will at some stage renegotiate our relationship with the EU in an attempt to maintain access to the single market.

Our position and what we advise our clients is to sit tight and take no knee jerk reaction, we are in uncharted waters but that doesn’t mean it’s the end of the world as we know it.

We have set out below some interesting material provided to us that gives some information on what may happen and tries to put recent market movements into context.

Please call us if you wish to discuss any concerns you may have, we look forward to serving you in these interesting times.

FTSE 100 movements

Today’s vote heralds a dramatic & profound change to the UK’s position in the world. However it is important to take stock of events.

The chart below shows the trajectory of the FTSE 100 Index since 2007 – and puts recent events into perspective when compared with events during the Great Financial Crash of 2008.

The result was clearly a surprise with Sterling suffering a 7% fall in value against US Dollar to trade at its lowest level for 30 years. For UK equities, £200 bn was wiped off the value of the UK stock market in just 10 minutes of opening as well as major falls in other global equity markets, whereas the typical ‘flight to safety’ assets of US Dollar, Japanese Yen, gold and UK gilts all rallied. We have now seen the market bounce back from its earlier intra-day lows however Sterling and equity market volatility was as expected given the Brexit confirmation, especially as these markets had been positioning itself for a Remain victory in the days leading up to the result.

More bounces in asset prices and currencies are to be expected over coming days as the re-rating process of the markets takes its course. However we have heard reassurances from the Governor of the Bank of England that this will not be a re-run of the Great Financial Crisis of 2008 as UK banks are much more highly capitalised and rigorously stress tested than then. Nor is there any expectation of a global trade collapse as then. The Bank of England has also announced an additional £250 bn of funding and to do what it takes to support an orderly functioning of the financial system, as the UK economy starts to transition its relationship with the EU.

What we can expect now is an intense focus on just how today’s momentous events will play out over time. Nobody knows for sure as the implications are highly complex and will take time to manifest themselves. However such complexities include (not exhaustively) the possibility of:

  • Further UK interest rates cuts and additional monetary & fiscal stimulus measures to stave off the recessionary risks.
  • The extent of any economic slowdown in the UK & Europe and the response from the ECB and other central banks, particularly whether the Fed continues to defer an interest rate rise.
  • What the nature of the UK’s trading relationship with Europe will actually look like and how soon trade deals will be negotiated – what impact this will have on company earnings, particularly the larger FTSE 100, where 75% are generated outside of the UK.
  • The fall in Sterling whilst good for UK exports, makes imported goods more expensive, so potentially stoking inflationary pressures. When combined with a likely slowing economy, an environment of stagflation could take hold.
  • Given the general uncertainty, a credit down grade from the current ‘AAA’ status for gilts – resulting in a loss of confidence from international investors which has wider implications for bond yields and currency.
  • The risks associated with the developing political landscape in the EU. Calls for a similar exit referendum are already being voiced elsewhere. The political elite in the EU may view further integration as the best solution to keep it from unravelling further.
  • If immigration levels fall, demand for commercial and residential property in the UK may decline, particularly in London and the South East.
  • The prospects of a break up of United Kingdom as the independence genie is now well & truly out of the bottle.

We are clearly in uncharted waters. High levels of uncertainty, from both economic and political perspectives (given the announced exit of David Cameron by October and votes of no confidence for Jeremy Corbyn), is never a good thing for investors.

But the lesson learnt is not to make any rash panicked investment decisions before the dust has had a chance to settle. Along the way there will be good opportunities for long term investors to benefit both from asset allocation & sector/stock selection decisions at much more attractive prices. The way this can be best managed is via a diversified long term strategic asset allocation plan such as the tried & tested asset model deployed in RMB Financial Management.

The asset allocation models we use provide a set of risk calibrated asset allocations offering diversification across a range 15 core asset classes. They have been proven to deliver a smoother journey for investors, and successfully weathered the 2008 Global Financial Crisis, the worst in living memory.

These asset allocation models are provided to us by Distribution Technology, they unanimously decided at its most recent meeting (in May 2016) that there would be no changes to asset allocations ahead of the Brexit vote. The capital market assumptions used are based on various long term economic forecasts however they will be carefully considering these (in addition to the asset allocations) at the next meeting in the light of latest research and emerging consensus views.

In summary we believe the best course of action is to sit tight and weather this potential storm, just as we did during the 2008 financial crisis.