fbpx

Everyone LOVES a winner… but no LOVE for BREXIT…

Everyone LOVES a winner… but no LOVE for BREXIT…

Despite last month’s Brexit referendum, Britain still hasn’t formally started the process of withdrawing from the European Union. Let’s be honest, it was a little bit of a shock for financial markets which had been confident that Britain would vote to Remain in the European Union, a victory for the Leave outcome by around 52% to 48% which triggered an abrupt bout of “risk off” in financial markets late last week. There is little doubt that it was probably also a shock to many Brits themselves some of whom seem to be going through a bit of BREGRET (thinking they were just delivering a protest vote against the establishment and assumed that Remain would win anyway). Of course, it needs to be kept in perspective and it is unlikely to plunge the global economy into recession.

 

As we are sure you are aware by now the United Kingdom (UK) has somewhat resoundingly voted to LEAVE the European Union (EU). This was against the run of the opinion polls and the betting markets in the final few days before the vote, shocking the citizens of the UK and the aftershocks of which are reverberating around the world.

 

The official vote tally of the referendum showed:

‘Leave’ camp received 17,410,742 votes, which was approx 51.9% of the total.

‘Remain’ took 16,141,241 votes, 48.1% of the total.

brexit-1

The UK are being shown the door – Auf Wiedersehen!

RISKS AND UNCERTAINTIES:

The vote to Leave poses several risks but it is not ALL doom and gloom for us down under!

 

  • LOWER UK ECONOMIC GROWTH – For the UK economy it’s no ideal news. According to estimates from the UK Treasury and the OECD the impact on trade, the financial sector and labour mobility could leave the UK economy 5% or so smaller than otherwise in 15 years’ time. In the short term there is a risk of recession given the blow to business confidence as UK businesses will be uncertain about their continued access to the EU. Of course the negative impact on the UK economy will be partly offset by a weaker British pound and making UK businesses more competitive.

 

  • POLITICAL INFLUENCES – Political uncertainty won’t help with Prime Minister Cameron to step down by October, uncertainty over the leader of the opposition Labour Party, pro-EU Scotland pushing for another independence referendum and some in Northern Ireland pushing for integration with Ireland.

 

  • DOMINO EFFECT – For Europe it will help fuel fears that some Eurozone countries may seek to follow the UK, setting off a DOMINO EFFECT, much as had been feared regarding a Grexit (or Greek exit from the Eurozone) over the last few years. This could see a tightening in financial conditions as investors fear a break up in the Euro.

 

  • GLOBAL UNCERTAINTY – Renewed uncertainty regarding Europe in turn poses risks to global growth, much as we saw through the Eurozone debt crisis of 2010-2012. This risk in the short term could simply come via tighter financial conditions in Europe and if we see a flight to safety out of the Euro into the $US this may take us back to the global growth fears we saw earlier this year.

 

  • ANTI ‘THE ESTABLISHMENT’ – The Brexit vote also highlights and threatens to add momentum to a backlash against establishment economic policies and specifically to a move away from economic rationalist policies in favour of populism and a reversal of globalisation which would be a negative for long term global economic growth. The shift away from globalisation could also add to geopolitical instability (note: Russian President Putin and Donald Trump were supporters of a Brexit).

brexit-beckons-as-97-of-britons-think-david-cameron-cant-get-a-better-eu-deal1

JOKES – Let’s divide our country right down the middle!

MARKET REACTION:

Reflecting the worries about the impact on the UK and more significantly Europe, financial markets reacted sharply in “risk off” fashion on the Friday of the vote with the British pound (-8.1%), British shares (-3.1%), the Euro (-2.4%) and Eurozone shares (-8.6%) down sharply and this saw global share markets down generally along with the $A. Safe haven assets such as bonds, the $US, Yen and gold have all benefited. This could have further to go in the short term until some of the dust settles.

In recent news, the British pound dived to a fresh 31-year low against the US dollar overnight, as three commercial property funds worth about 10 billion pounds ($17.4 billion) put a freeze on investors pulling out their money.

1466389931544

That awkward moment(s) when you were wrong…

OVERZEALOUS MARKETS…

PERSPECTIVE, PERSPECTIVE, PERSPECTIVE! The moves in some markets were EXAGGERATED because the gains that occurred during the first four days of the last week before the vote when markets thought Remain would win had to be reversed.

  • Britain has only started down a process to exit and has a long way to go yet. At this stage it still has all the benefits (free trade) and obligations (free movement of people) of a full EU member. It will first need a new PM, then formally notify its intent to exit which will then kick off a negotiation process that will take up to two years.
  • It’s doubtful that Eurozone countries will actually seek/vote to leave because the hurdle to leave the Eurozone is higher than Britain leaving the EU as it will mean adopting a new currency, paying higher interest rates, etc. Just think of Greece despite its woes over the last few years consistently deciding to stay in the Eurozone. Britain has always identified itself as being less European than other European countries. And it’s notable that people in the rest of Europe see the EU/Eurozone as a source of strength and force for peace and less as a driver of economic prosperity.
  • The bottom line is that Brexit is unlikely to knock the global economy into recession and we see little reason at this stage to change our expectation for continued moderate global growth.

 

THE POSITIVES OF BREXIT:

From an economic and financial market perspective the decision to the ‘Leave’ the EU might be a difficult one to understand, and financial markets have certainly had this response. However, it must be accepted that a majority of the people in the UK see positives in leaving the EU, well at least thought they did…!

The overall argument for leaving centres on returning sovereignty to the UK, but there are also some more specific potential positives.

  • Membership fee – Last year the UK paid £13bn into the EU budget, but only received £4.5bn of spending, a net contribution of £8.5bn. However, while leaving the EU would appear to offer an immediate cost saving, it is unclear how much would be realised in practice as most nations with access to the single market must contribute in some way to the EU budget.
  • Trade – Outside the EU, the UK will be free to establish its own free trade agreements without being bound by EU law in areas such as agriculture, justice and home affairs.
  • Regulation – Free from compliance with EU legislation, the UK would be free to set its own regulation without outside influence.
  • Finance – Without EU membership the UK would be free to regulate financial services as it sees fit, protecting it from potentially burdensome EU regulations.
  • Immigration – Leaving the EU will mean that the UK can resume control of immigration and limit the flow of EU migrants; as well as exclude them from in-work benefits.

 

IMPLICATIONS FOR AUSTRALIA:

Given that only 2.7% of Australian exports go to the UK and that the Leave victory is unlikely to plunge Europe into an immediate recession, the main impact on Australia will be on financial markets. This could affect short term confidence and may add to the case for the RBA to cut interest rates again, although with our own political uncertainty, it is more likely that RBA Governor Glenn Stevens will keep the additional rate cut up his sleeve for the time being. That being said, we expect the RBA to cut rates again anyway and a falling $A will ultimately provide a shock absorber for the Australian economy if the global economy and financial system really gets hit. Overall, Brexit barely changes the risk of recession in Australia which is low.

 

WHAT TO WATCH?

Key indicators for investors to watch include the following:

  • Geopolitical events in Europe – the key event in the short term is the Italian referendum on Senate reforms to be held by October. This is necessary for economic reform to succeed in Italy. Next year will also see a Dutch general election and French presidential election.
  • If the ‘who’s next’ guessing game really heats up…
  • Eurozone bank share prices are also worth watching given this is where financial stress will show up in Europe.
  • The nature of the Brexit – a minimalist Brexit (like Norway’s arrangement) would send a strong signal dissuading other Eurozone countries from doing the same.
  • A renewed surge in the value of the $US – this would be bad for the global economy and signal problems in China, commodities and the emerging world. The US money market now sees a greater chance of rate cuts (albeit 10-14%) than of rate hikes (zero chance) at the July and September Fed meetings and sees only a 15% chance of a hike by year end.

 

7535598-3x2-340x227

A LOVE affair no more.

CONCLUDING COMMENT:

We are now going through what is traditionally a rough time of the year for investors (“sell in May and go away…”), and the Brexit vote is contributing to that this year. In addition, our own political hurdles The key for investors is to either look through the short term noise caused by the Brexit decision or look for investment opportunities that it throws up as investment markets become oversold. We hope this was an enlightening summary for you and provides you with a sound understanding about what we know and what we need to keep an eye on.

If you would like any advice on how the Brexit or other global uncertainties may affect YOU, YOUR BUSINESS, or YOUR INVESTMENTS.
Please don’t hesitate to get in touch with our office on (08) 8341 0022.

#BREXIT #Leave #DoomAndGloom #StayPositive #Overreaction #GoodbyeEU

Source: AMP Capital

Share this: