Brexit

A great blog from Dan Norman of TCF Investments

Summary
• Equity markets have sharply fallen in the wake of the Brexit vote
• But the falls have not been calamitous for UK equities
• Undoubtedly uncertainty has increased and higher risk premia are being demanded
• The focus now should be on fundamentals and the long term, rather than short-term noise
• The UK economy will withstand Brexit shocks
Details
The news that the UK electorate has voted to leave the EU has been dimly received by financial markets.
Equity markets are down following the vote, as they previously moved to be expecting a “remain” result.
That said, it is perhaps telling that the current level of the FTSE 100 does not show the sort of calamitous falls indicated by news organisations and politicians:

Asian markets also fell heavily overnight as the UK vote outcome became clear. Sterling too has fallen in the foreign exchange markets. In contrast gilt prices have increased.
It is difficult to predict what will happen from here. In the short term, the reaction of the US equity market may be pivotal. If it shrugs off the news with a relatively small fall, shares elsewhere could rally significantly. The fall in Sterling is likely to be longer lasting.
What seems more certain is that markets will remain volatile over the coming weeks and months as they digest the full implications of Brexit, not only for the UK, but for Europe as a whole. In light of the above, markets have entered a period of heightened volatility.
We do not believe a knee jerk reaction is appropriate. In times like these we believe that smart investors should be focused on long term fundamentals rather than short-term noise. Nothing has fundamentally changed and the UK economy is not going to come to a sudden halt and nor shall the global economy. But a UK exit from the EU will bring increased uncertainty for businesses and this will affect their investment intentions as well as investors assessment of the risks.
But we believe that the UK economy will be flexible enough to withstand the shock that this vote has brought and the price of Sterling will act to absorb much of this impact. It is important to recognise that around 75% of FTSE 100 companies’ revenues come from abroad and these will directly benefit from the lower price of sterling. Indeed, if the increased risk premium demanded by investors eases in the period ahead, then the FTSE100 may see a boost.
The economic impact of the UK leaving the EU is effectively unknowable, but in the grand scheme of things we expect the impact to be relatively limited – economies and their agents will adapt, and the shock of the result will dissipate over time. Although uncertainty will remain, with the referendum complete we expect markets to get back to focusing on more substantive issues, which we have been continuing to monitor carefully even while much attention has been temporarily diverted.
But arguably, Brexit may be more of an issue for European economies. How the politics and economics play out for Europe will no doubt be interesting. European markets have taken the Brexit news badly and we think that it is important to keep a close eye as the full implications of Brexit become apparent.
We have not held large views on individual equity markets in the run up to the Brexit vote, although we are adopting a marginally overweight position in equities overall. This position is the mirror of our negative stance on bonds, where we see little value, given the historically low yields, from medium and long term perspective.
Uncertainty around how the UK actually leaves the EU and on what terms will remain for the foreseeable future, but is likely to fade into more of a background process. In the meantime, there are more significant factors to consider that are likely to have broader ramifications on globally-diversified portfolios, and we will continue to monitor the investment outlook and act accordingly.
It is important to stress to investors the importance of taking a long term view, subject to their individual circumstances. And so whilst volatility has undoubtedly increased, and this will continue, the solid building blocks of long-term financial planning (diversification and building a portfolio in relation to long term goals and attitude to / tolerance of risk) remain intact.

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