An unexpected outcome?


The UK electorate turned out in the millions to vote in favour of leaving the European Union. Once again the leading pollsters got it wrong and some bookmakers are also nursing heavy losses. Our own customer poll accompanying our recent blog revealed a significant majority of you supported Brexit.

‘once again the leading pollsters got it wrong’

On Friday morning whilst the country was still digesting the news an announcement came that David Cameron would step down from office in October. The Labour leadership came under pressure and the political finger pointing all started to take shape and it came thick and fast. Whatever the motivations of the voting public, we are not here to make judgements. Willis Owen followed the campaigns and arguments closely and as stated our own polls confirming a leave decision was more likely than not.

I am sure that like me you will have many questions but at this early stage in the process to withdraw from the EU, any predictions can only be highly speculative and it will be weeks or months before we get an indication of the true impact on the economy as we have no historical precedent to refer to. As a financial services provider we focus on the impact the ensuing changes might have on your investments.


What are the main political and economic implications?


The next Prime Minister will be tasked with invoking the Article 50 exit clause of the Lisbon Treaty. EU leaders have said they wish it to happen as speedily as possible, although a Parliamentary vote is required and there is a prescribed 2 year negotiation period.

It seems likely that some of the prominent Conservative MPs who formed part of the ‘Leave’ campaign will be working on potential new trade arrangements prior to this exercise but we do not yet have much clarity on what these might look like. Various models used by other countries, from Norway to Albania and Canada, have been suggested but putting theory into practice will take time.

There is also the question of whether other countries such as Denmark and the Netherlands will seek their own referendum on EU membership and closer to home whether Scotland decides to have a second referendum and separate from the United Kingdom.

With regard to the economic outlook the general consensus is that growth in the UK and Europe will undoubtedly slow; even Brexiteers advocated ‘short term pain for long term gain’. The difficulty is assessing the extent of the slowdown and whether it will be serious enough to have an adverse effect on global growth. Obviously a drawn-out or acrimonious exit would prolong the uncertainty.

‘the general consensus is that growth in the UK and Europe will undoubtedly slow’

While some initial statements and views suggest other countries are positioning themselves to be at the table with the UK to negotiate an early deal, one of the main concerns is that investment plans which have been clearly on hold ahead of the referendum will now be delayed further or even cancelled. The UK has been a major beneficiary of Foreign Direct Investment (FDI) and without it the risk of recession is elevated.

Overall, the forecasts for the reduction in UK GDP growth range from 0-9.5% by 2030 with the Treasury at the higher end.

Respected income fund manager Neil Woodford has stated his belief that ‘Britain’s long term economic future would be largely unaffected, although UK GDP will be lower over the next 18 months’.

The more commonly held view is that there will definitely be some long term negative impact while in the short term there is a fairly high chance of a recession; Schroders put this at 35-40%. AXA Investment Managers have reduced their GDP forecast from 1.8% to 1.5% for this year and from 1.9% to 0.4% for 2017 but there is much divergence amongst forecasts given the considerable unknowns.

Monetary policy could be tightened with interest rates cut to zero if the economy shrinks more than expected and further Quantitative Easing cannot be ruled out. It is uncertain whether at some point rates may actually have to rise if imported inflation becomes a problem and currency weakness persists.

We also anticipate a negative effect on Europe’s economy which may stall its tentative signs of recovery. Beyond Europe it is impossible to quantify the impact of Brexit but do remember there are other important factors which will affect the global economy including a US Presidential Election this year, a French General Election next year and ongoing worries over China’s escalating debt.

Of course, whatever economists predict, it is apparent that for UK companies, including Willis Owen, it is ‘business as usual’. Many have been quick to communicate this message to employees and customers; assuring them that they are adaptable when faced with change and will seek to turn challenges into opportunities.


How did the stock markets react to the news?


The early casualty was the Pound which fell to a 30 year low as traders switched into safe haven currencies such the Japanese Yen and the Swiss Franc. As ever in uncertain times the perceived security of Gold and Government Bonds pushed their prices higher.

Share prices also retreated as markets opened, with the FTSE 100 initially down over 8%, after sharp falls in Asian markets overnight. By Friday’s close the FTSE had recovered to finish 3.1% lower and it was European markets which sustained bigger losses on unease about the future viability of the entire EU. The benchmark indices in France and Spain were down more than 8% and 12% respectively.

Companies holding up best were defensive multi-nationals such as Unilever which will benefit from their products having a competitive price advantage in export markets. Holders of overseas funds investing in regions such as Japan may have seen their valuations actually rise despite sharp falls in the markets due to the currency effect.

In the UK stock market among the worst hit sectors were: Financials, on worries over pressure on margins and loss of access to Europe via ‘passporting’ arrangements; Housebuilders (sitting on expensive land banks if house prices fall) and Retailers (the cost of goods they import could increase while domestic consumer demand falls). The property sector also came under pressure; most funds invest in commercial property and there are fears that capital values will fall if there is an exodus abroad, particularly from London.

‘It is an encouraging sign that buyers significantly outnumbered sellers on Friday’

However, high rental yields from tenants with long-term contracts should provide some downside protection. The Mid and Small Cap sectors with their domestic bias were marked down harshly and indiscriminately not helped by inferior liquidity.

On the positive side it is also worth remembering that these sharp falls followed several days of gains on expectations that Britain would stay in the EU.

Indeed the FTSE 100 actually finished 2 % up over the week and above the psychologically important 6000 level. It is an encouraging sign that buyers significantly outnumbered sellers on Friday implying that confidence has certainly not evaporated.

George Osborne delivered a speech after the weekend which aimed to calm markets by announcing the implementation of contingency plans drawn up by the Treasury, the Bank of England and the Financial Conduct Authority. Currency markets were helped by the Bank of England’s pledge to make available £250 bn to support Sterling and ensure market liquidity.


Not a Time to Panic


We cannot deny there may be turbulent times ahead but markets tend to overreact in periods of uncertainty. Significant setbacks have historically proved to be good opportunities to add to holdings at potentially bargain basement prices. Recent reports showed that UK Fund Managers had lifted cash levels to 15 year highs ahead of this event and no doubt their teams of analysts will have compiled lists of stocks best placed to benefit in either scenario. We suspect some of this money is already finding its way into carefully researched investment opportunities.

The forthcoming period of economic and political uncertainty may cause ongoing high levels of volatility in the markets so broad diversification of your portfolio will be more important than ever.

This could be through a multi-asset fund which invests across a range of assets, a Global fund such as Fundsmith which invests in Blue Chip multi-nationals with well known brands and high market shares or by building your own basket of funds with a range of asset classes and geographies.

For those individuals who are concerned about a fall in capital values or the volatility in the market there may be a case for temporarily raising cash levels (if invested in a tax wrapper consider its cash facility rather than a complete withdrawal).

‘time in the market has proved to be more important than timing the market’

Alternatively, the more cautious investor may prefer a Diversified Growth or Income Fund or an Absolute Return fund both of which have capital preservation as their primary aim. We expect continued demand for UK Government Bonds as investors favour low risk assets. Investors seeking a decent income may opt for a Strategic Bond fund which tries to identify the best opportunities across the fixed interest asset class.

Investors with a long term horizon should bear in mind the fact that, over longer periods, time in the market has proved to be more important than timing the market as the steepest falls are often followed by equally sharp recoveries.

Identifying turning points, especially when volatility is high, is extremely difficult so once you have a well diversified portfolio it may be better to resist the temptation to tinker too often.

However, for those with spare cash putting a little into the market on down days might prove to have been a sensible strategy when we look back in a few years time.

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