WEEKLY REVIEW 24TH JUNE

Brexit: the decision

The week has been very clearly split into 2 parts: the 4 days leading up to the announcement of the result of the UK’s referendum on EU membership and Friday, which is turning out to be ‘the morning after the night before’ for many investors.

In the first 4 days of the week, equity markets rallied strongly across the globe in the belief that the momentum enjoyed by the Leave campaign in recent weeks had stalled and that a Remain vote was by far the more likely outcome. Even where local events were a cause for concern, such as in India where the unexpected announcement on Monday that the central bank Governor, Raghuram Rajan, will step down when his term ends in early September caused markets to open lower, these concerns were overcome by more positive sentiment globally, helped by the efforts of the Modi administration to calm investor nerves after the surprise announcement. Dovish comments by Janet Yellen during her testimony in Washington, promising to proceed “cautiously” when it comes to raising interest rates, merely added to the ‘feel good factor’, with most economists now expecting the Fed to hold rates for the next couple of meetings.

Alongside this ‘risk-on’ rally, safe haven assets sold off, with gold falling below $1,258 per ounce. The high level of confidence that the market had in the outcome of the vote was reflected as well in sterling, which had risen to nearly $1.49 by the time markets closed in the U.S. on Thursday. In fact, the confidence so strong that, after talking to ex-colleagues, Nigel Farage, leader of the UK Independence Party and a former commodity trader, was even driven to admit that he thought that the Remain camp had edged the contest before having to “unconcede”. However, doubts emerged as soon as the first results came in, with Leave doing better than expected, and sterling fell sharply, at one point down by over 11% to the lowest level since 1985 at $1.32 (it recovered subsequently to $1.39 before falling back again to below $1.37). Equity markets fell in concert as the realisation dawned that markets (and bookies) may have got the result very wrong, giving back all of the gains made in the first 4 days of the week and moving into negative territory. The biggest faller on the week so far is Japan, with the Nikkei falling 5.6% after trading was suspended early after a daily fall of 7.9%. As we write, European equities are down even further on the day at 8.3% for a weekly loss of 3.0% but it remains to be seen where the market closes. UK equities were down by a similar amount shortly after opening but have recovered to be down by a still very significant 5.2%. However, after a very strong rally in the first part of the week, this equates to a weekly loss of just 0.5%, again better than Europe at 3.0%. Even the relative safe haven of equity markets, the U.S., is called to open 4.0% lower today, which would mean a weekly loss of 2.3% with a whole trading day to go. This makes the best performer on the week the Hang Seng which, in spite of a 4.2% loss today, fell by just 0.8%, although this may simply be as a result of the market closing before the full result was known so there may be more pain to come at opening on Monday.

Unsurprisingly, safe haven assets in all forms rose as sharply, across a range of asset classes from commodities (gold) to German Bunds (fixed Interest) to the yen (currency).

Issues under discussion

As you can imagine after such a major event, some of the ramifications will not become clear for several weeks or even months and, whilst we have all probably had enough of the campaigning and discussions about the potential outcome of the referendum to last a lifetime, the actual process of negotiating exit from the EU will be far more drawn out and tortuous than anything that we have seen yet. Therefore, it may well be that some opportunities do not present them selves for some time, possibly not until markets have moved on to the next big issue (as they invariably will), so we are minded to be patient and not act rashly.
In terms of what the next big issue (or issues) may be, it seems likely that politics will play an important role in investors’ thinking in the foreseeable future. The result of the UK referendum has lead to the Prime Minister, David Cameron, announcing that he will step aside and it will be interesting to see how the ruling Conservative Party elects a new leader whilst attempting to heal the wounds caused by the rather brutal campaign. However, other European leaders have their own issues, with several European elections imminent and calls for similar polls coming already in The Netherlands and France from politicians riding high enough in their respective national polls to be taken seriously. Add to that the U.S. election due before the end of the year and investors may well have plenty of reasons to move on from Brexit to other issues sooner rather than later.
There is no doubt that our move to build a significant exposure to cash has helped to protect the portfolios from the worst of today’s events, especially where that cash was placed into US dollars, and we have discussed taking some profits by moving some of that cash exposure back into sterling. However, with a record current account deficit which will only be worsened by a weaker currency, alongside the possibility that the Bank of England may use the currency as a policy tool, dropping interest rates to stimulate growth whilst allowing it to weaken further, we believe that further falls in sterling are possible or even likely.