The Lowdown on Markets to 24th June 2016
World Markets at a Glance
In this week’s issue
- The British electorate votes to leave the European Union severing a 43-year membership
- The prime minister, David Cameron, steps down leaving others to negotiate with the EU
- A number of labour cabinet members resign doubting Jeremy Corbyn’s ability to lead.
- Global equity markets suffer from “Brexit Friday” but sovereign bonds and gold prosper.
- Sterling declines to its lowest level for many years as “Brexit” becomes a reality.
- Further volatility in global equity markets is likely but opportunities await stock pickers.
“The UK electorate decides it’s time to leave the European Union”
As future generations look back over history they will read that on the 23rd June 2016 the British public voted in favour to leave the European Union by a margin of 51.9 to 48.1 per cent, severing the countries 43-year old EU membership. This unanticipated result not only saw the British public vote in favour of us leaving the European Union, but it also heralded a political earthquake in the UK which led to David Cameron announcing that he would be stepping down as prime minister, leaving others to negotiate the UK’s delicate exit strategy invoke article 50 to redefine our relationship with the EU.
Rumours then followed that Labour leader; Jeremy Corbyn’s position was under some threat by some members of his party who were thought to be considering tabling a no- confidence motion, this was then confirmed at the weekend by the news that he had sacked his foreign policy chief, Hilary Benn, and that his Shadow health secretary, Heidi Alexander, and a third of his labour cabinet members had resigned in a “no vote of confidence revolt”.
“The voting voices of the British public have now been heard”
Also in the midst of this political upheaval came the news that the UK’s European Commissioner, Lord Hill, was standing down after stating “what is done cannot be undone”. Clearly, the voting voices of the British public have now been heard with regards to our membership of the European Union and the political fall-out is now very visible in both the government and opposition camps.
Clearly, as the referendum results began to filter through in the early hours of Friday morning a “sea of blue” in favour of “Brexit” became very apparent and the world’s global equity markets hastily turned into a “sea of red” as investors hit the risk aversion button. The overall votes from the leavers campaign came top in nine of the UK nations and regions, compared with just three for the remain campaign, and they were the obvious three, London, Scotland and Northern Ireland. Other important statistics showed that the turnout from voters was a healthy 72%, representing 30 million of the British people, by far a bigger response than in a normal general election.
“Equities, commodities and emerging market assets were those that were most heavily hit”
At first, we saw the Asian markets trade lower followed by falls in the UK and European markets as they began to open. Finally, Wall Street opened and like the other markets fell sharply and remained down over the day. Equities, commodities and emerging market assets were those that were most heavily hit, with specific sectors such as UK housebuilders, consumer services, employment agencies and banks coming under most pressure as investors feared that Britain’s exit would dent consumer and business spending.
Similarly, the FTSE 250 Index seems to have taken the brunt of the initial fall out as investors worried about its supposed domestic focus, but of course, the mid-cap index derives more than 50 per cent of its earnings overseas, equally many of these businesses will profit from weaker sterling through currency-related earnings upgrades, and tend not to suffer as much from a downturn in economic growth given that they do not need to restructure their business models as much as their larger brethren. Also there is a tendency for the small and mid-cap stocks to become prime candidates for mergers and acquisitions given their long-term growth potential.
“The sell-off in equities helped to push government bond prices up and yields down to near historical lows”
And in respect to Fridays wider global market sell-off, well according to S&P Global statistics the UK’s referendum vote to leave the European Union cost investors US$2.0 trillion, the worst one day drop in history, with the previous worst one-day sell-off being back in the September 2008 when we saw US$1.9 trillion wiped of the value of shares. In fact, Bloomberg’s Billionaire Index has also calculated that on Friday the worlds 400 wealthiest investors lost a combined sum of US$127.0 billion, making “Brexit” the biggest global monetary shock since 2008. However, on the flip side of the coin the sell-off in equities helped to push government bond prices up and yields down to near historical lows as demand heightened for “safe haven” assets. Other asset classes that were sort after were the yen, the US dollar and of course gold that soared to a two-year high.
Understandably, the government bond markets were in big demand from investors, which in turn, saw yields fall dramatically under the weight money. Indeed, in Switzerland almost the whole of the market for Swiss government debt traded below zero, with 30-year paper offering an annual yield of minus 0.04 per cent. Unquestionably these are unparalleled times as we see more and more of the government debt markets breach zero or subzero yield levels. Even in the UK the benchmark 10-year government gilt yield has now fallen to below 1.0 per cent and the likelihood of it falling much lower over the coming weeks is a distinct possibility.
Obviously, at this delicate moment in time the majority of investors were looking for a directive from the governor of the Bank of England, Mark Carney, and this he did, by saying that he would not hesitate to take the necessary measures required to stabilise the markets as they adjust to this extraordinary situation. With sterling having felt the full force of the referendum result, and share prices for the UK banks in freefall, he said in his statement that he, and the Chancellor of the Exchequer, had made provisions for such an event, including stress testing the banking system, stating that currently they have more than £600 billion of high quality assets. This in his opinion gave them substantial capital and huge liquidity in these challenging times.
“The Bank of England said it stands ready to provide more than £250 billion of additional funds through its normal facilities”
Moreover, as a backstop, and support for the functioning markets, the Bank of England said it stands ready to provide more than £250 billion of additional funds through its normal facilities. Also it was able to provide substantial liquidity in foreign currencies, if so required, and expects institutions to draw on this money and their own resources as needed to maintain stability within the sector. The governor went on to say that the Bank of England would assess the situation and financial conditions with the necessary actions taken thereafter. However, in respect to this statement many analysts now believe that the Bank of England will have very little choice over the coming months but to cut interest rates to zero and facilitate that extra funding.
Clearly, Britain’s exit vote from Europe has initially split the country, and our European friends, and of course, nearer home, it is likely that we will see a second Scottish referendum very soon, but of course, there is no guarantee that the European Union would indeed accept Scotland’s membership given that they have already indicated that they are part of Great Britain, and if Britain is out, then Scotland is out. Similarly, the Union will need to retain its existing members, support the euro, and survive itself, over the coming years.
“Europe is still facing a huge problem after many years of government and central bank intervention”
Arguably, if you put Britain to one side for the moment, then Europe is still facing a huge problem after many years of government and central bank intervention. For instance, if you look at incomes, there has been a massive slowdown in the rate of real incomes around the whole of Europe, and the wider OECD, this in turn, has created a serious political problem that cannot be resolved easily.
Indeed, even this week-end in the Spanish elections we have seen the left wing Socialist PSOE party take second place, and whilst the conservative People’s Party won most seats they still fell short of a majority. Admittedly, the left wing protest party Podemos popularity did not soar in the polls which might have been down to the UK’s surprising vote to leave the EU.
Similarly, whilst unemployment rates have been coming down across Europe there is still a huge swath of youth unemployment across many countries such as Greece, Spain, Croatia, Cyprus and Portugal all still suffering. Indeed, even if you look at the Eurozone overall then there is still over 10 per cent of the people out of work. And of course if you take Greece, it is still in serious trouble and is likely to be another country that exits from the European Union at some time in the future, with other EU member states looking to call for their own referendums over the coming years.
“It is fair to say that it is always wise to avoid knee-jerk reactions”
And so looking around the markets this week we are likely to see further uncertainties and volatility as investors try to analyse what has happened and what to do next. Firstly, it is fair to say that it is always wise to avoid knee-jerk reactions, admittedly, it may seem very uncomfortable in short-term but selling into markets during periods of panic has generally been proven over time to be very ill-advised, “you don’t want to be selling ice cubes to the Eskimos” you want to be buying bargains and there is no better time when we have corrections of this scale.
If you look back to the Lehman’s collapse and subsequent financial crisis we saw the markets correct aggressively before they bottomed out on the 09th March 2009, subsequently, since then the equity markets have rallied and produced the second longest bull market in history. Admittedly, 2016 has been a difficult year for stock markets but it’s over the longer-term that investors should always focus upon.
“There are plenty of global companies that have very strong balance sheets”
Certainly, the markets are likely to gyrate around over the coming weeks, especially with so much uncertainty, but this will present investment opportunities and there are plenty of global companies that have very strong balance sheets, little or no debt, sizeable cash flows, and increasing dividends, which in this low interest rate and government bond yield environment we find ourselves is a very attractive proposition.
Admittedly, over the coming years higher levels of volatility, and uncertainty, should be expected and perhaps the buy and hold strategy will be tested, but never-the-less time in the market, whilst timing the market through a drip feeding strategy will be a powerful combination. However, what we urge clients to do most is to try and look through these periods of uncertainty and focus on the longer-term opportunities that still remain.
Peter Lowman Chief Investment Officer
Peter Lowman has been in investment management for over forty years and prior to becoming Chief Investment Officer for Investment Quorum, he worked within a larger asset managers, primarily as an Investment Director with Cazenove’s. He is responsible for the overall investment strategy for Investment Quorum clients and sits on the Investment Quorum Committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority .