What does the UK's vote to leave the EU mean for investors?

What does the UK's vote to leave the EU mean for investors?

UK votes to leave – what next?

The situation is unprecedented:

There is no verified or tested procedure for EU exit

This means it is uncertain what happens next, but it is plausible that:

Article 50 of the EU constitution – the law governing the process of the UK’s divorce from the EU – will be triggered
This will kick-start the formal two-year process determining the terms of the UK’s EU exit, including the shape of its future access to the Single Market
There will be significant pressure on Prime Minister David Cameron to resign

Economic impact - UK

Like the Bank of England,* we think that the leave vote will probably have a negative short term impact on UK economic growth, because of:

  1. Increased uncertainty and reduced confidence depressing private consumption and fixed investment
  2. Increased risk premia in UK bond markets and potentially higher borrowing costs
  3. Increased uncertainty, risk aversion, and possibly higher funding costs in the UK financial sector

Note: a weaker pound is likely to support exports and the Bank of England may cut interest rates, mitigating the overall adverse impact

Market impact - UK

In the short run, investors can expect:

Shock to investor confidence and increased UK asset price volatility
Further declines in the pound, adding to the 5% depreciation versus the euro YTD
Downward pressure on UK equities, especially financial sector stocks and those most reliant on EU migrants (e.g. construction, hospitality sectors). Less pressure on UK companies with large FX earnings
Modest upward pressure on Gilt yields is possible owing to increased uncertainty, higher risk premia and the prospect of higher inflation due to the weaker pound (although initially yields could fall due to a flight to safety)
Upward pressure on UK corporate bond yields owing to increased uncertainty and the worsening short term growth outlook – as with equities, the financial sector is most exposed
Modest declines in UK house prices are possible, owing to reduced buyer confidence and a possible uptick in unemployment

Impact on Europe

Modest direct economic impact:

European companies with significant UK exposure and assets may cut back on investment until uncertainty about the UK’s future EU engagement eases
Uncertainty may also have some negative impact on EU trade with the UK
If the adverse economic impact looked significant, the ECB would likely expand its asset purchases, reducing the risk of a worse-than-expected economic outturn

But some impact on European markets:

Short term pressure on equities, especially for European companies with significant UK revenue, trade and investment exposure, and particularly so if the euro rises
In bond markets, perceived safe-haven yields may compress while corporate bond yields and spreads may increase; as with equities, the financial sector is most exposed
In the longer run, the UK leave vote could bolster other euro-sceptic movements, raising concerns about the wider EU project; this would be most negative for peripheral country assets

Managing volatility

From time to time, equity markets experience heightened, event-related volatility.

In such times, it can be helpful to keep in mind:

Volatility is a normal part of long-term investing
Avoid being swayed by sweeping sentiment
Long-term investors are usually rewarded for taking equity risk
Market corrections can create attractive opportunities
Active investment can help navigation in periods of increased volatility

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