With Britain’s “exit” vote winning the referendum on European Union membership, 51.9 per cent to 48.1 per cent, the reaction has been strong, as markets generally expected the vote to swing the other way.
ANZ’s chief investment office awaited the Brexit vote already holding a defensive investment position, supported by concerns about softer global growth, China’s troubles with growth and rising US inflation.
We’re continuing to this position, but it may be a bumpy ride in the near and short term.
What to expect
- Under Article 50 of the EU Treaty there is a two-year negotiation period on Britain’s departure. Until Article 50 is triggered the timing of the exit will remain uncertain. Realistically, even if Article 50 is invoked, negotiations are likely to take much longer than two years. Adding to the uncertainty, British Prime Minister David Cameron has resigned with a new leader set to be in place by October. The current lack of certainty and stability means that the markets are likely to remain volatile.
- The Bank of England, the UK Treasury, International Monetary Fund, National Institute of Economic and Social Research, and private-sector analysis predicts that leaving the EU would cause a downturn in Britain’s economy. Over two years most analysis suggests the UK economy could contract by around 3 per cent to 4 per cent of gross domestic product and possibly by as much as 5 per cent to 7 per cent of GDP over the medium term.
- While Brexit will likely be a significant headwind for the UK, we view the direct impact on the global economy as relatively small, perhaps a drag of around 0.2 per cent from global growth over the next year or so. That said, with global growth already soft the impact on market sentiment will not be a positive.
- Importantly, possible contagion to the rest of Europe could continue to erode confidence. Markets will now assume risks of other EU members, either exiting or re-negotiating EU membership, are substantially higher. That said, in contrast to Britain, where the referendum was called by the ruling conservative government, other EU political parties that could favour an EU “exit” are not in a position to call a referendum for now.
British Prime Minister David Cameron is expected to leave office by October.
- We have already seen the pound sterling, Britain’s domestic-focused stocks and financial stocks swing lower. Assets that usually weaken when markets are more uncertain, such as the Australian dollar, European shares (particularly in peripheral markets like Italy and Spain), Japanese shares and emerging market currencies, have also moved down.
- To date, financial stocks have borne the brunt of the adjustment, particularly across European peripheral markets. Over the week to June 24, Italian bank stocks are down around 13 per cent, Spanish banks by around 11 per cent while German banks are down by around 3 per cent. British banks and stocks more broadly have been somewhat better supported, possibly reflecting the large fall in pound sterling which has provided some offset to foreign earnings.
- Defensive sectors including consumer staples, real estate investment trusts and, somewhat surprisingly, commodities have held up somewhat better over the week to June 24.
- The impact to US shares has been more muted, although a sharp and broad-based strengthening of the US dollar would be a headwind to US earnings, commodities (apart from gold) and emerging markets. US bank stocks are down around 3 per cent over the week.
- There has been a spike in the “safe haven” assets that usually strengthen when markets are more uncertain, such as the Japanese yen, Swiss franc and US dollar. As well as high-quality bonds such as US Treasury and German bunds.
- While we expect large market swings, the Bank of England and a range of other central banks have drawn up contingency plans to deal with the fallout from a Brexit, by injecting liquidity. This could work to sooth markets and prevent a prolonged correction.
- All up, while we may see large swings in the markets we expect that they will eventually moderate given that central banks will step in and overall there is only likely to be a moderate impact to global growth.
Our investment viewpoint
While Brexit will intensify pre-existing concerns regarding soft global growth, the Chinese transition to softer more domestically driven growth and fears about a steady lift in US inflation, it does not significantly change our assessment of the global economic outlook.
The impact is clearly negative in the short term. Longer-term implications are highly uncertain and very much depend on any further EU member states moving to leave. This, along with the actual exit process of Britain from the EU, may take years, not months, to play out.
We expect the fallout from the vote to leave will keep monetary policy easy for longer across the developed economies. This will likely provide some support for sharemarkets, but we continue to remain cautious towards such risk assets given the still modest pace of global growth.
The Brexit vote and its implications support ANZ’s cautious investment strategy to growth assets but does not change it. Opportunities may emerge to invest more defensively if growth assets continue to weaken in the weeks ahead. However, we are not at that point as yet and remain cautious towards growth assets as markets continue to digest the implications of last week’s Brexit vote.
Mark Rider is ANZ Wealth head of investment strategy and portfolio management.