Is fear of domino effect on EU markets sparked by Brexit and current changes in UK good for the equity of the investors?

With strong leadership and creative approach UK might be the winner by leaving the European block behind. But only if the new leader will decide to take unconventional approach and make some decisions which won't win him much popularity in short term.

The uncertainties and unknowns thrown up by the Brexit vote late last month continue to hang over global financial markets, but as the immediate dust settles one thing is clear, funds aren’t flowing in favour of Europe.

In fact, while the UK stock market has recovered just about all the losses it made in the aftermath of the vote, European stock markets continue to post losses.

The reasons for this could be that there is still fear of the impact that the departure of the UK, the world’s fifth largest economy, will have on the economies of the 27 EU members left behind.

Or is it an even greater fear that Brexit could well spell the end of the union itself?

I call it fear of the domino effect.

Brexit contagion

In my view, the risk of contagion in Europe remains real and could rise if the UK under strong leadership appears to be prospering from leaving. I believe this could also threaten a re-run of the euro crisis and could explain why fund flows for European assets are currently negative even as the markets bounce.

At the moment, with the UK in political turmoil and forecasters such as those at Capital Economics already suggesting that growth could slow rapidly to 0.1% in the second quarter from 0.4% in the first, the country could hardly be the ideal for others in the EU to emulate.

But, with a new leader for the ruling Conservatives likely to emerge in a couple of months’ time and with policy makers already taking steps to boost confidence and stimulate the economy, chances are that in time Brexit may not be quite the disaster many seem to think it is now.

The so-called domino effect of other countries looking to leave the EU has receded as a risk for now but it could easily reappear, especially if the UK does not appear to be harmed and indeed is seen to be benefiting from leaving.

A Brexistential crisis

This, of course, is the last thing European leaders want and explains why so many have them have not only called into question the future Britain faces but also demanded that the country rush into Article 50 negotiations that could be unfavourable.

However, policymakers in the UK may well have been one step ahead, with the Bank of England promising further monetary easing to lower the cost of borrowing and boost growth and the Treasury is looking at plans to cut corporation tax by at least a quarter.

This would obviously be a positive signal for the UK equity markets were it to occur. Indeed, it might actually be a trigger for some competition between the UK and the remaining EU bloc, which could again likely be positive for equities.

As we all know, though, the key area of negotiations as Britain extracts itself from the EU is trade.

UK has the opportunity to come out quite aggressively in support of more free trade agreements, even declaring a principle of zero trade tariffs with everyone it trades with, helping not only UK consumers but also the exporters from non-EU countries, especially those in emerging markets.

With the world’s fifth largest economy leaving a customs union and emerging from behind a trade barrier, there are many opportunities.

If anything, countries outside of the single market appear to have benefited rather more in terms of increased exports to Europe than those inside it.

Pound loss envy?

On top of all this there is the simple matter of the pound and its decline to its lowest level in three decades since the Brexit vote. Much of this volatility was to be expected and may not be welcome in some quarters but for UK exporters it is a boon that many exporters in the EU will be looking at with only envy.

Finally, for those fearing the domino effect there is politics and the rising calls from populist parties across the EU for similar referendums to be held there.

These calls are only likely to intensify if Britain’s Brexit appears to be working and my conclusion is that the risk to markets has to be that there is some sort of domino effect.