Brexit

I have had reports articles from a number of fund managers recently and the overall feeling is that this is a political event and not a financial event like the global financial crisis. One manager feels there is a 75% probability that this is not negative over the long term. Over the short term however markets will likely be volatile.

Below is Harbour Asset Management’s view on investment implications:

The largest reaction to the Brexit vote has been in the foreign exchange markets, where the British Pound (GBP) has fallen to its lowest level since 1985.  This reflects that Brexit is first and foremost a British political crisis, and a sharp depreciation in the GBP is the best way to help the UK economy through the economic adjustment. 

For broader global capital markets, increased uncertainty means global trade and economic growth forecasts will need to be trimmed. Similar to the post ‘Grexit’ market uncertainty the cost of capital for some asset classes will increase, particularly some more marginal credit issuers. And market liquidity may dry up for some asset classes, meaning price volatility may increase. As there is very little scope to provide policy support via monetary policy, pressure will build for other forms of stimulus. This will be a challenge for those countries that are already in a difficult fiscal position.   

In the lead up to the EU referendum we needed to ask some key questions. Has the market priced in the potential range of outcomes? Has it over/under stated the risk? Our analysis suggested that while capital markets had allowed for some degree of Brexit, with bond yields falling to recent low levels and equity markets softening, a full Brexit and potential EU contagion event had not been priced in. While we remained relatively fully invested through the Brexit period we kept liquidity available to take advantage of investor overreaction.

Markets may have over-reacted in the near term, and some asset classes may be oversold. But there is a significant amount of uncertainty to work through, and a recovery may be hesitant.

We have and will make selective investments after careful analysis. 

Markets face a number of known events currently, for example, changes to US federal monetary policy and US federal elections, which may have a range of impacts on asset class returns.  Arguably markets always face known events, but the current crop of events seem to be influencing investor confidence more than usual.  Referendums, elections, geopolitics and central bank policies all increase investor uncertainty. They often contribute to investors ‘doing nothing’ but they can lead to investors making short term investment decisions that are inconsistent with long term objectives.   As Citibank highlighted in a recent report ‘it is challenging to consider a period when doubt did not loom and clarity was evident – think Grexit fears, financial crises in the US, periphery Europe and Asia over the years, the Cold War, Japan’s lost decades, etc’. Uncertainty and limited visibility have been a factor in all of these events. New technology which allows information to be shared everywhere, all the time, with everybody may not be reducing uncertainty.

Harbour Navigator 27 June 2016