As anticipated with the Brexit announcement, there has been a pronounced sell off in risk assets:
- Sterling has suffered significantly, falling 10% against the U.S. dollar and trading below 1.34 against the US dollar. Futures on global equity markets have fallen in overnight trading, with FTSE Russell® 100 futures falling over 8% and futures on the S&P 500® Index falling around 5%.1
- U.S. Treasuries have rallied strongly, with the yield on the 10-Year bond falling by 30 basis points. We can anticipate a similar reaction in UK gilts as a result of a flight to safety and in anticipation of forceful response from the Bank of England.2
- Further out along the yield curve, the full implications remain to be seen during the day’s trading and beyond. This risk off driven rally will likely drive yields down at the longer end of the curve. However, the potential inflationary pressure of sterling weakness may mitigate some of this impact.
- In volatility markets, Chicago Board Options Exchange Volatility Index (VIX) futures are reacting to the news of Brexit with a strong rally; futures are currently trading at 25.25 an increase of more than 35% since last night’s close.3
The implications for investors
As we look forward, the implications of this decision are hard to predict. The political and economic landscape in the UK and further afield will alter dramatically over the coming days and weeks. The long process of negotiating an exit and subsequent international relations begins immediately but no one can be sure of the timetable or outcome.
Contagion into the rest of the EU?
On Sunday, the Spanish general election may provide some indications of the broader anti-EU voice. It is likely today’s result will increase calls for referendums in other EU states, including Denmark, Sweden and the Netherlands. To a large extent, the UK’s experience in negotiating an exit over coming months will continue to shape the future of the EU for some time.
The impact on global financial markets
At this point in time, the immediate sell-off in risk assets and the flight to safer investments is an understandable reaction, especially after markets rose over the last week as investors priced in a ‘remain’ vote. Over recent years, financial markets have been driven by the expectations and reality of monetary policy, and today’s result will no doubt delay the path of monetary policy tightening in the U.S. and the continuation of a more accommodative stance in the UK and Europe.
However, we should not over-read the impact of this event on global market volatility. Our Annual Global Market Outlook report for 2016 has been dominated by expectations of heightened market volatility, triggered by events such as this. With the UK representing about 4% of global Gross Domestic Product (GDP), its ability to cause a major economic shock is limited.
The uncertainty presents risks but also opportunities
In an environment which exhibits heightened volatility and where there is no clear direction for markets generally, we continue to believe in a dynamic approach, reacting to market events to “sell the rallies” or where appropriate “buy the dips”. Identifying the signals in the noise is a challenge requiring a disciplined approach. After a multi-year bull market for equities, the recent environment has been one where risk management has been, and will continue to be, paramount in protecting returns. Across multi-asset portfolios, this is achieved through diversification, particularly away from pure equity risk and through the use of options to structure a more attractive risk reward pay-off.
Over the coming days and weeks, the ramifications of the UK’s decision will continue to be felt both domestically and internationally. The resultant market disruption comes as no surprise and our investment strategist and portfolio management teams continue to identify ways to both help to protect against risks, but also importantly look for potential opportunities to help add value where market reactions are out of line with our fundamental expectations.
1Source. Bloomberg LLP. As at 24 June 2016 2Source. Bloomberg LLP. As at 24 June 2016 3Source. Bloomberg LLP. As at 24 June 2016