Asset managers see protracted uncertainty plaguing markets
In early analyses of the UK’s shock vote to leave the European Union (EU), asset managers stress the uncharted nature of the political process Britain is about to embark on and the prolonged uncertainty this may mean for financial markets.
While some firms point to the emergence of buying opportunities following initial market tumbles, others are revising down growth forecasts for the UK.
In particular, the UK referendum result – which last night saw 52% of votes cast in favour of leaving the EU against 48% to remain in – heightens the risk of further disintegration of the union by fuelling exit pressure within other countries including Italy, Germany and France, to exit, they say.
Strategists and portfolio teams at BlackRock said: “We expect the UK divorce to be messy, drawn out and costly.”
It will involve unpacking UK and EU laws and striking trade deals with a spurned EU and the rest of the world, they said.
“We expect potential losses in services exports and investment flows to overwhelm any benefits of lower payments to the EU,” BlackRock said.
The vote to leave is likely to be a catalyst for a series of highly unpredictable political dynamics, according to Legal and General Investment Management (LGIM)’s Hetal Mehta, European economist, and strategist Christopher Jeffery.
They pointed out that UK prime minister David Cameron has so far said that the decision on when to trigger that withdrawal process will be a matter for his successor.
“The referendum result is only politically, not legally, binding on the UK government,” the pair said in a commentary.
“It is unclear, at this stage, whether the UK’s decision to leave will require ratification by Parliament in the coming weeks.”
Since more than two-thirds of members of Parliament supported the ‘remain’ campaign, this is unlikely to be a particularly harmonious process, and a fresh general election cannot be ruled out, Mehta and Jeffery said.
Candriam said that, even though the Lisbon Treaty of 2007 clarified the process for a member state to exit the EU, what would actually happen now was far from clear.
“The referendum is, indeed, only an advisory referendum,” it said, adding that it could be weeks or months before formal approval comes from Parliament.
It pointed out that, when Greenland decided to leave the European Community in 1982, it took three years to reach a deal.
“The UK has 65m inhabitants, it exports a myriad of goods and services to the EU – 40% of its exports – and is financially deeply integrated with the EU,” Candriam said.
The negotiation process between the EU and the UK is bound to be long and complex, with numerous political and legal hurdles, and the effect of this on the economy will be difficult to assess, it said.
At State Street Global Advisors, global CIO Rick Lacaille, said: “While the vote to leave has immediate market implications, over the longer term, observers will be wary of the impact the vote has on other nationalist and protectionist movements – both in Europe and elsewhere.”
Nationalist parties will feature prominently in elections next year in Germany and France, he predicted.
“There is the potential for knock-on consequences for market-moving issues like trade, labour mobility and foreign investment,” Lacaille said, adding that just how the EU balanced facilitating a swift UK exit to reduce risk as quickly as possible, and discouraging similar movements in other countries, was key.
David Page, senior economist at AXA Investment Managers, said the referendum result had prompted it to revise down its UK GDP forecast for 2017 to 0.4% from 1.9%.
The UK economic outlook is likely to be hit severely by the decision to leave, and the economy seems to have sagged under the uncertainty of the referendum itself, with deferral of activity, he said.
“The decision to leave the EU looks likely to make much of this deferral permanent,” Page said.
Rory Bateman, fund manager and head of UK and European equities at Schroders, said the sharp fall seen in the UK stock market was a de-rating and not a fundamental earnings decline.
“Given that over 78% of FTSE 100 revenues are derived overseas, as well as the incremental effect from weaker sterling, it seems unlikely there will be a significant earnings hit, despite the expectations the UK economy will suffer post the Brexit result,” he said.
Value opportunities could emerge, and firms with global exposure may outperform, Bateman said.
“At some point, there will be a compelling value opportunity for European equities, induced by the market rapidly pricing in a worst-case scenario driven by Brexit,” he said.
Bateman said that, even though there appeared to be no Brussels ‘Plan B’ for the Brexit outcome, EU authorities may quickly say that a Free Trade Arrangement is unacceptable without free movement of people.
“However, the UK is unlikely to accept free movement of people given that immigration has been the central tenet of the Brexit campaign,” he said.
On the manufacturing side, the UK could well adopt World Trade Organisation (WTO) tariff arrangements, which would at least be quantifiable across different sectors, he said – for example, 10% for the car industry.
The market would quickly price the consequences of the tariff change in, he predicted.
Neuberger Berman struck a calming note in its commentary, cautioning against reacting as if this were a second “Lehman moment”.
“The likelihood of at least medium-term damage to the UK economy from a leave vote, as well as pronounced market volatility on the back of political uncertainty for the UK and the EU as a whole, did lead us to adopt a relatively neutral stance in portfolios coming into the vote,” it said.
But it had also positioned neutrally, partly to make sure investors were in a position to take advantage — potentially by adding to riskier assets based on a longer-term view of fundamentals, the firm said.
The European Central Bank (ECB) said it was closely monitoring financial markets in the wake of the referendum result and was in close contact with other central banks.
“The ECB stands ready to provide additional liquidity, if needed, in euro and foreign currencies,” it said in a statement.
The bank said it had prepared for this contingency in close contact with the banks it supervises and considered the euro area banking system to be resilient in terms of capital and liquidity.
Mark Carney, the governor of the Bank of England, said this morning that, as a backstop, and to support market functioning, the UK central bank was ready to provide more than £250bn (€326bn) of additional funds through its normal facilities.
“In the coming weeks, the Bank will assess economic conditions and will consider any additional policy responses,” he said.
BlackRock said the magnitude and volatility of the British pound’s fall would probably trigger further responses from the Bank of England.
“We expect the central bank to cut its 0.5% policy interest rate to zero soon, and see it returning to quantitative easing rather than pushing rates into negative territory,” it said.
Credit rating agencies are expected to adopt negative outlooks for UK government bonds, with downgrades to follow quickly, according to BlackRock.