Waverton's thoughts on Brexit

We summarise our views on the Brexit vote on 23rd June

Waverton does not claim to have any special predictive powers on the result of the June 23rd Brexit vote but we have tried to analyse the potential effects on our clients’ portfolios.  Like our peers and our clients, we can scrutinise the polls (notoriously unreliable as demonstrated from the recent Scottish Referendum and UK General Election) and the latest odds from the bookmakers, but all we know for sure is that the vote will be close and, in the event of a “Leave” result, the impacts will be uncertain.  We can be fairly confident that such uncertainty will result in increased volatility across all asset classes, providing both risks but also, ultimately, opportunities.

Our base case is that Britain votes to stay in the EU.  This view concurs with 87% of financial professionals who responded to a survey by Credit Suisse in March as well as the UK bookmakers.  This position is also partly drawn from studying the history of referenda across the world.  Where the potential outcome may result in unknown risks, the public generally votes to retain the status quo. 

In this piece we have attempted a one paragraph snap shot of the key issues.  This is obviously an enormous simplification of some very complex topics but we hope will provide a bite sized reference point of Waverton views.  As you will expect the outcomes remain finely balanced further complicating any conclusions;

  • Type of Brexit – the complication around drawing conclusions on this subject is that it all depends on what we are left with.  Are we being asked to leave just the EU or the entire Single Market or somewhere in between?

  • GDP - estimates vary, but some of the more negative imply a 2-5% impact on UK GDP on a 2-3 year time horizon, caused by corporate and consumer uncertainty delaying investment decisions.  The financial services sector in London will almost certainly suffer as some global financial companies relocate, with effects on London residential and commercial property.  The impact on foreign investment into the UK is uncertain.

  • Inflation - Should sterling weaken, the effect on imports is likely to be inflationary (import-driven inflation) in the short term.

  • Interest Rates - The most likely outcome is that a vote to leave the EU will encourage the Bank of England to extend the period of loose monetary policy, either with bank rates going to 0% and QE being reinstated or by delaying the first interest rate hike. However, the Bank of England will face a difficult dilemma should the above mentioned inflation risk take hold.  

  • Gilt yields - Based on the above, one could make a case either way on the outcome for Gilt yields.  For example the short-end may benefit from the flight to quality on uncertainty alongside the potential for monetary policy to be loosened further.  However, Gilts may also suffer from selling pressure from overseas investors (according to the UK DMO this group still owns 26% of Gilt issuance).  There is also a case to be argued that the potential for inflationary impacts could see Gilt yields rise (more pronounced at the long end).

  • Sterling – Sterling has already weakened and is the “front line” of the Brexit fears as demonstrated by the increased cost of buying currency insurance.  It is very much the consensus view that the value of the £ versus the US$ would fall (estimated at between 10-15%) in the days and weeks after a vote to leave the EU.  However, with only 30% of the UK plc’s sales and profits being domestically driven (Citi research) Sterling weakness would have some immediate translational benefits to much of the FTSE 100.

  • Continental Europe – The risk to Continental Europe should not be underestimated and has probably been under-analysed.  The potential for the Eurozone periphery to destabilise on a “Leave” vote is very real with impacts on peripheral bond markets a particular concern.

  •  Opportunities – The volatility that the forthcoming referendum is likely to create will also provide opportunities.  In the Bank of America Merrill Lynch fund manager survey in March 13% of global investors saw Brexit as the biggest tail risk for global markets which is up from just 8% the previous month.  Furthermore, in the same survey, UK equities are now the least favoured stocks globally on a 12 month horizon – possibly a contrarian buy signal.

Written by Rupert Elwes and Charles Macfadyen

Risk Warnings

The views and opinions expressed are the views of Waverton Investment Management Limited and are subject to change based on market and other conditions.  The information provided does not constitute investment advice and it should not be relied on as such.  All material(s) have been obtained from sources believed to be reliable, but its accuracy is not guaranteed.  There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.

Changes in rates of exchange may have an adverse effect on the value, price or income of an investment.

Past performance is no guarantee of future results and the value of such investments and their strategies may fall as well as rise.  Capital security is not guaranteed

The information relating to ‘yield’ is for indicative purposes only.  You should note that yields on investments may fall or rise dependent on the performance of the underlying investment and more specifically the performance of the financial markets.  As such, no warranty can be given that the expressed yields will consistently attain such levels over any given period.