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24th June 2016
EU Referendum

Market Commentary July Flag News

As we are all fully aware, the United Kingdom voted to leave the European Union after over 40 years of membership. Whilst the political and economic ramifications of this decision are still unfolding, the impact on the markets is already being felt.

Markets opened on Friday morning in complete shock. Sterling was down by over 10% against the dollar to the weakest level since the 1980s, the largest swing in sterling ever seen. By the time equity markets opened at 8am, the hysteria had spread to the stock exchange with the top 100 UK companies down over 8% (550 points) and the more domestically biased mid cap index down over 12%. Hidden within these broad measures of stock market levels were some truly big share price falls. Companies that had exposure to the UK economy (exempli gratia housebuilders, commercial property, media, financial services and consumer discretionary) were down between 30% and 40% within 15 minutes. Whilst a hard-fought recovery was won from the day’s starting lows, the political developments of the weekend saw another exceptionally weak day on Monday. On the back of this, most safe haven asset classes such as government bonds and gold have rallied to all-time highs and multi-year highs respectively. It is understandable that the market has taken such a cautious stance when it is faced with such a high degree of political, economic and legal uncertainty.

Looking at the probable economic effects of the vote, there are several areas that are likely to be in focus. First of all, inflation – which has been subdued over the last few years – is likely to increase due to our imports becoming more expensive in most global currencies. We have already seen inflation expectations for 2017 rise to over 2% on the back of the vote; but it is likely that a part of this will be offset by a slowing domestic economy. If the economy does start to slow due to a combination of weaker consumer spending, falling house prices and poor business confidence, then it is inevitable that unemployment will rise from the historically low level of 5.1%. Even though house prices have been falling in London since the start of the year, it is difficult to tell how material falls may be across the country. Irrespective of the potential short to medium term gyrations of house prices, the UK builds about 100,000 too few homes per year and has been doing so for many years. This fundamental supply and demand imbalance will underpin house prices in the longer term unless there is a comprehensive supply side response. It does seem increasingly likely that the UK may enter recession whilst there is so little knowledge about how our future relationship with the European Union will be. Recessions unfortunately become slightly self-fulfilling in the fact that if people believe there will be one, then less money is spent and less business is done, which thus causes an economic decline.

The final area of interest is the seismic shift that we have seen in the political landscape with both parties seemingly rudderless and emotions running high. It is still far from clear when Article 50 will be invoked, if Scotland will call another independence referendum and whether a general election will be called after party politics have settled down.

All of this paints a deeply uncertain picture of the investment landscape. Uncertainty leads to fear, fear to panic and panic to hysteria. We have uncertainty across politics, economics and finance and until this gets resolved it is likely to be a challenging period for stock markets. It is important to remember, though, that investment is very much focussed on the long term, and markets have successfully dealt with the oil crisis, Black Monday, leaving the ERM, the dotcom bubble, the global financial crisis and the series of Greek tragedies. The world may change dramatically but it still carries on; and investments in solid companies over the longer term will deliver attractive rates of return.  The turbulence that we will see will provide opportunities for the rational and thoughtful investor; and by having a higher weighting in lower risk assets and cash, we stand well placed to capitalise on opportunities as and when they arise.