Brexit backlash – the fallout for investors

The mood in London is universally glum after last week’s Brexit referendum was won by the “leave” party. Even the exiteers are feeling blue with many now regretting their vote. The reaction from the EU is also contributing to global market uncertainty and instability within the region, which may perpetuate slower economic growth worldwide.

The exit campaign leaders appear uncertain about what to do next

In fact, as they did not expect the win they appear to have no plan at all, setting the stage for massive political internal infighting. The Scottish National Party’s Nicola Sturgeon believes that she may be able to block a Brexit, or failing that, is considering staging a second Scottish independence referendum that could allow the country to join the EU in its own right.

A Brexit in some form remains by far the most likely outcome

There is a small chance however that the exit may not happen at all. There are precedents in this regard, not least the Danish public voting against the Maastricht Treaty in 1992, only to renegotiate and then ratify it via a second referendum in 1993. Given the referendum is advisory only, the government has the final say whether to implement. Interestingly, the majority of MPs appear to be in favour of staying, but there will likely be public dissatisfaction if they don’t follow the wishes of their constituents.

In or out, London will remain a pre-eminent financial hub

London straddles both the Asia and US time zones, allowing traders access to numerous markets. In addition, its mother tongue is English, it has strong existing laws, regulations and infrastructure, and London remains an attractive place to live. Furthermore, banks, fund managers and insurance companies are unlikely to spend money completely relocating staff who live, work and educate their children in London. And the city of London and the UK authorities will likely move heaven and earth to keep them.

That said, there are a lot of issues to work through

The level of the fallout on whether the UK will really be missed in the EU remains to be seen, but the coming weeks and months will be filled with uncertainty that will no doubt create volatility. In our opinion, Europe (and for that matter the UK) still remain uninvestible at this stage and caution should be taken if considering investment in the region. The Brexit is not the only challenge on the EU horizon, the region is also battling sluggish economic growth and the immigration crisis on top of the need to implement significant structural reforms to stabilise the economy, the currency and the global share market.

So what does the Brexit fallout mean for Australians, especially investors?

We will likely see more volatility, a flight to safety in the US dollar, central banks will flood markets with cash to attempt to stabilise, and global growth will likely slow as consumers keep their hands in their pockets and wait to see what will happen next. The UK and Europe may drop into recession in the short term. Beyond the financial market impact, there are also potential trade implications. On the upside, our dollar has rallied against the pound, which is good for travellers to the region. It is important to remember Britain is not leaving the EU immediately and this process will likely play out over the next few years.

The investment outlook requires a lot of thought

For local investors, there are considerations to factor in now. While central bank liquidity provision may support prices of risk assets in the near term, in our opinion this is not a compelling buy signal from a strategic perspective as key risks remain unresolved. For the last few years our general recommendation has been to avoid Europe, retain US dollar exposure, remain cognisant of the huge geopolitical risks in the world, maintain portfolio diversification and keep sufficient cash. In our view this general strategy continues to make sense as the situation will not play out quickly and patience is key. At some stage there may be opportunities generated by volatility. 

As a general recommendation, this strategy does not take into account your objectives, financial situation or needs. As always, your personal circumstances are critical when considering any financial strategy and seeking professional personal advice is highly recommended.

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Patrick Broughton

Investment Committee Member

Patrick has 32 years of investment banking experience spanning over a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange.

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