The voters have spoken and they want out of the European Union. There have been sharp geographical divisions – Scotland voted overwhelmingly to remain with the EU but the margin of victory has been far greater than expected.
Equity markets have fallen sharply, the pound is already under considerable pressure, gold is rising strongly and bond yields are sure to drop. The Bank of England is widely expected to intervene although it will probably be reluctant to ease rates in a hurry and will probably wait to see how things pan out.
What are the political implications? David Cameron will continue as Prime Minister in the wake of this embarrassing defeat until October and will then step down. Will this be the trigger for the government to call a General Election? And what of Scotland – will Nicola Sturgeon now press for a second referendum for the country to leave the UK? The referendum result has created uncertainty on many fronts and it will be some time before there is any clarity on many of these issues.
In the meantime, the FTSE 100 has fallen by approximately 5% in initial trading. As recently as ten days ago it was trading at 5923 and the 7% gain since then has immediately evaporated. It is likely that the leave vote will probably send the UK index back towards its February low and that still looks possible – that would imply a total drop of 13%. Should 5500 fail to hold the next downside target will be the June 2012 low, at 5260
At the time of writing the UK currency has slumped by approximately 10.5% since yesterday’s close, which would be its biggest ever one-day decline. This move has taken it through the lows posted in the depth of the financial crisis and to a level not seen since 1985 (the year in which it fell to $1.05). So where will it bottom out? That is a tough call but one key level could be at round $1.30. which would represent a 161.8% extension of the first down-wave of the decline that began in July 2014. If that level fails to provide support it is not at all clear where sterling will come to rest but, given the already oversold levels evident on short-term indicators, a near term break below $1.30 would be surprising. Further ahead, however, the outlook is unclear and Morgan Stanley’s $1.25 looks possible.
As I write sterling has slumped by approximately 10% against the euro (and bear in mind that the single currency is also coming under considerable pressure this morning – it is down by approximately 3.6% vs the dollar) The long term chart shows that this weakness has taken it back to – and marginally through the uptrend of the last seven and a half years and that line could yet provide some support. Should it fail, however, the next downside target will be €1.19
It is showing a rise of approximately 6% this morning in reaction to the referendum vote – and the uncertainty it will engender. This move has lifted it decisively through the top end of its recent range ( at $1301 or so) and to its highest reading since July 2014. Although the trade is likely to remain choppy in the near term the overall impression is that there is scope for further upside before this move is over and the next target it now looking like $1380 or so.
The vote by the people of the UK to exit the European Union is a momentous decision and clearly has implications for investors and businesses in the UK and across Europe. The UK economy will of course ‘survive’, given its entrepreneurial flair, increasing focus on non-EU trade, and likely policy accommodation by the Bank of England and UK Treasury. However, getting to the next stage looks a long, drawn-out ‘can of worms’, leaving uncertainty for UK assets and markets. The extent of this damage now rests on the manner of the exit.
The UK Parliament must now decide when to act upon the referendum result. There will then be a period of transition where the implications, details and timings of the exit will be scrutinised and negotiated. The outcome of these negotiations cannot be predicted with any certainty, however we will continue to monitor the market and data vigorously
Please be assure that we have been very defensively positioned within our portfolios over the last year we are not substantially overweight in equities. We have a healthy weighting to alternative assets (property and hedge funds) as well as decent weighting to fixed interest securities which should continue to perform well during this transition period. The consequence of the vote on the UK domestic economy and Europe more broadly is difficult to call and will likely only be evident over time but the fall in the currency increases the competitiveness of those sectors exporting both goods and services internationally and should increase the appetite for inward investment over time.
If we look at the corporate sector in particular, we are in an environment where companies are holding significant cash balances and the scope for ongoing corporate activity remains. This should limit the extent of the falls that we should see over the coming weeks and months.
History has taught us not to be panic sellers as all of our clients have a medium/long time horizon but please be assured we take managing client asset seriously and will not be afraid to take decisive action if required.