EU referendum result - comment from RLAM

24 June 2016
Latest comment from Trevor Greetham, Head of Multi Asset, Royal London Asset Management on the impact of the UK’s vote to leave the European Union.

Trevor Greetham said:

Our base case was for a Remain vote in the referendum and we went into the summer only modestly overweight stocks as we thought there would be shocks that would create longer term buying opportunities. The Brexit shock puts the world into Plan B. The outcome of the referendum is a major surprise to stock markets and sterling which were trading positively as the Vote Leave camp lost its lead in the polls.

Uncertainty about future trading and regulatory arrangements will act as a major drag on the UK economy, the world's fifth largest, and will have a knock on effect in Europe.

Unsurprisingly, stock markets have been hit very hard. This could create a longer term buying opportunity for stocks as markets tend to overreact to bad news in the short term. There is a silver lining though, turmoil in Europe will stay the Federal Reserve's hand in hiking interest rates and will probably trigger a new round of stimulus.

Whatever the UK is doing, most economies are expanding, monetary policy is loose and this is a positive backdrop for stocks.

Foreign exchange markets have been very volatile. However, this will have had limited impact on performance as the portfolios are slightly underweight sterling as a result of their above benchmark exposure to overseas equities.

Commenting on the macroeconomic impact, Ian Kernohan, Economist at Royal London Asset Management, said:

Given the sharp rise in uncertainty for households and firms, it now seems sensible to assume a UK recession in the second half of this year, with spending decisions postponed until the situation becomes clearer. The longer-term impact on economic activity depends on the new trading arrangements which the UK must now negotiate with the EU and the rest of the world. As of today, the UK remains a member of the EU and new arrangements will take some years to arrange.

Following the fall in sterling, the Bank of England has recognised the risk and indicated its ability to support the currency if the need arises. A weaker sterling will act as a support for economic activity and help to attract the capital inflows necessary to finance the large current account deficit, but it will also push up import inflation. I would expect the UK Government's fiscal strategy to be reassessed in the light of these events: while the budget deficit is still high relative to the rest of the G7, there is some room to slow the pace of fiscal austerity, especially when Government borrowing costs are so low.

US Federal Reserve rate hikes will now be off the table until after the November election.

Commenting on the impact of the vote on the UK stock market, Richard Marwood, Senior Fund Manager, said:

The weakness of the pound will give companies with large amounts of overseas earnings a boost, as the sterling value of those earnings will be higher. It should also improve the competitiveness of UK companies that export and make the UK more attractive as a destination for overseas tourists. The currency move, coupled with share price falls, could also make some UK companies more attractive bid targets for overseas companies, but those overseas potential bidders are likely to be deterred by the uncertain backdrop.

The weak pound is going to increase the cost of imported goods for many companies, which may ultimately be inflationary. With so much uncertainty around, companies and individuals are likely to defer major financial decisions, leading to deferral of investment and staff hiring by companies and reduced activity in the housing market.

Ultimately the equity market does not like uncertainty and the leave decision means that there will be a prolonged period of such uncertainty. We should expect share price weakness and very high market volatility.

Commenting on the outlook for government and corporate bonds, Ewan McAlpine, Senior Client Portfolio Manager, said:

Markets around the globe have reacted sharply to a surprising result versus the expectations of the final run-up to the referendum. So far in UK markets we have seen something of an over-reaction: gilt yields have fallen below last week's lows, reflecting the degree of uncertainty in outlook for the future and in risk assets. Credit spreads have widened so far this morning, undoing the tightening of recent weeks.

While the outcome is a negative one for the UK economy, there are many details of the UK's separation from the EU and around new trading arrangements still to be decided. We would expect to see some recovery from initial short-term moves. Portfolios remain positioned for a medium to longer-term view that the global economic situation will continue to improve. We believe that Government bond yields will rise, but positioning in portfolios will continue to be tactically managed amid high levels of volatility.

We believe credit bonds will outperform Government bonds and that portfolios should focus on security of cash flows and the delivery of stable and attractive returns over the medium to long term.

Last updated: 24 Jun 2016

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