Philip Saunders and Ken Hsia give their views on the EU Referendum result.
The views expressed are those of the Portfolio Manager at the time of publication. They may not reflect the views of all the portfolio managers at Investec Asset Management. Any opinions expressed are honestly held but are not guaranteed and should not be relied upon.
Co-head Multi-Asset Growth
The result of yesterday’s referendum on whether the UK should stay within the EU led to a narrow victory for the Leave campaign. Whilst the polls had indicated that the voting would be close, there had seemed to be a growing consensus that the result would be to Remain and this seemed to be priced in to stock, bond and currency markets. We, therefore, feel that there may well be considerable short-term volatility in the wake of this surprising outcome. We believe, in the near term, markets will be pre-occupied by the following issues:
- Will ‘out be out’? Uncertainty will continue with the possibility of a further referendum. The actual exit process will not start until Article 50 of the Treaty on European Union is triggered.
- Currency volatility: Sterling has fallen sharply from levels that were effectively discounting a sufficiently convincing remain result. UK fundamental factors, chiefly a yawning current account deficit and a struggling property market are becoming less supportive1. Central Banks are likely to step in quickly to prevent excessive turbulence.
- Populist backlash: The euro and indeed European assets reflected little in the way of EU fragmentation risk, but the populist backlash is clearly not a purely UK phenomenon.
- UK equity market turbulence: UK equities have weakened sharply on the futures market and continued uncertainty will depress multiples and valuations. It will be important to discriminate between stocks that are likely to be affected by largely domestic cyclical factors, which need not be long lasting, and companies, such as banks, which may be affected more structurally. The market is unlikely to discriminate at first and hence, for those able to adopt a company by company approach, this would represent a longer-term advantage. Many UK-listed companies would actually benefit from sterling weakness either through improved competitiveness or from the translation of overseas earnings.
- Downturn in UK property: Listed UK property assets, which had been particularly adversely impacted from the last quarter of 2015 on Brexit concerns, are likely to reverse their recent gains. With much of the re-rating due to structurally lower long-term interest rates ‘in the price’, further weakness is possible.
- Depressed credit markets: European credit markets are likely to be negatively impacted in the short term, with credit spreads moving wider. Sterling denominated issues and UK bank credits are likely to particularly adversely impacted.
- Macroeconomic stability & dovish Fed: We believe that globally investors are generally cautiously positioned given growth concerns. The removal of referendum related uncertainty, although a continued problem for UK assets in particular, makes this a less comfortable position given recent macroeconomic stability and a softer rates stance on the part of the US Federal Reserve Board. Defensive assets, such as government bonds, may rally temporarily and riskier assets will arguably be negatively impacted in the short term. Thereafter, both will be impacted by global fundamentals and investor positioning.
Markets tend to adjust rapidly and sometimes overshoot. Investors are generally better off not reacting to the outcome of the referendum over the short term. Over the longer term economic and corporate fundamentals will drive investment returns.
- At 4.3% of GDP (IMF’s 2016 projection) the UK has the largest current account deficit of any advanced economy
- At 3.6% of GDP (Economist) the UK’s budget deficit is the third largest among advanced economies, topped only by Japan and Greece
- The UK has a trade deficit of US$190 billion, the second largest in the world after the US
- The UK has US$2.2 trillion debt outstanding, the third largest in the world after the US and Japan.
Portfolio Manager, European Equity
The electorate voted for the UK to leave the EU in yesterday’s referendum. We will watch the initial reaction of capital markets with interest. However, we believe currency movements are likely to be more significant, as we have seen already in the immediate reaction to the referendum result. In the aftermath of the referendum we note:
- In the short term we expect to see elevated volatility in the equity markets as a whole, not just in the UK but across Europe (with similar shockwaves across other regions of the world). Given the lack of economic understanding of the real medium to long term effect of Brexit on trade agreements and company fundamentals, this short term volatility will be more based on reactionary sentiment based trading.
- We await the real impact on trade agreements to unfold. There are indications that all existing trade agreements may hold for at least two years until new agreements come into effect. We believe, the sectors most likely to be impacted by changes to trade tariffs are agriculture and manufacturing, as services see no industry-specific export. Both the agriculture and manufacturing sectors are small on a UK basis (0.7% and 11% of GDP respectively). However, we believe that uncertainties will lead to investment and purchasing decisions being delayed by consumers and corporates.
- As regards capital markets we will await the reaction of the European sovereign bond market as well as the UK and European central banks. With quantitative easing in Europe in place since March 2015, we would be surprised to see yields expand and hence stability should remain on that front.
- Overall the degree of pragmatism will dictate near term developments. The UK people have given their message and we will observe the pace at which this new agenda is embraced. It would be a surprise to see obstructions to the economic recovery Europe is experiencing. With easy monetary policy, there is upside as well as downside risk within the stock market. With equity markets yielding in great excess of bond markets, we believe, there are sectors which can grow dividends even in a tougher environment.
European Equity Strategy:
We have raised the hurdles for investments into UK stocks and have explicitly considered the risks an out vote poses to individual companies as part of our research process. We continue to run a balanced portfolio and will rebalance when necessary according to our 4FactorTM investment process.
This communication is for information only and nothing herein constitutes investment advice. The value of this investment, and any income generated from it, will be affected by changes in interest rates, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which it invests. The Fund’s investment objective will not necessarily be achieved and investors are not certain to make profits; losses may be made. The Fund may use or invest in financial derivatives. The value of the units in the fund and the income accruing to the units, if any, may fall or rise. Past performance figures shown are not indicative of future performance. Investment involves risks. Please refer to the offering documents for further details, including the risk factors.
All the information contained in this communication is believed to be reliable but may be inaccurate or incomplete. Any opinions stated are honestly held but are not guaranteed and should not be relied upon. The portfolio may change significantly over a short period of time.Investors may wish to seek advice from a financial advisor before making a commitment to purchase units of the Fund. In the event that an investor chooses not to seek advice from a financial advisor, he/she should consider carefully whether the Fund in question is suitable for him/her.
It is not an invitation to make an investment nor does it constitute an offer for sale. The full documentation that should be considered before making an investment, including the Prospectus and Product Key Facts Statement (KFS) or Product Highlights Sheet (PHS) (where applicable), which set out the fund specific risks, is available from Investec Asset Management or your financial advisor.Investec Asset Management and its subsidiaries only provide information about its capabilities, products or services. All of the views expressed about the markets, securities or companies in this press comment accurately reflect the personal views of the individual fund manager (or team) named.This document contains statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual results may differ materially from those stated herein. There can be no assurance that these forecasts will be achieved.In Hong Kong, this document is issued by Investec Asset Management Hong Kong Limited and has not been reviewed by the Securities and Futures Commission (SFC). The company website has not been reviewed by the SFC and may contain information with respect to non-SFC authorized funds which are not available for to the public of Hong Kong. In Singapore, this document is issued by Investec Asset Management Singapore Pte Limited (company registration number: 201220398M). In Indonesia, Thailand, The Philippines, Brunei, Malaysia and Vietnam this document is provided in a private and confidential manner to institutional investors only. This is the copyright of Investec and its content may not be reused without Investec’s prior permission. Outside the US, telephone calls may be recorded for training and quality assurance purposes. Issued by Investec Asset Management, June 2016.