Brexit

Impact on financial markets ahead of the EU referendum

With an increasing focus on ‘Brexit’, our investment clients will naturally be monitoring the impact on financial markets ahead of the referendum scheduled for Thursday 23 June.

The nature of investment is long term. Constantly making changes to take into account short-term events often proves to be counterproductive in the long term. Movements in currencies and shares are often fairly short-lived, as the result of the Scottish referendum showed.

Analysis, predictions and arguments

In the run up to 23 June, we are going to hear all sorts of analysis, predictions and arguments about the likely results of the UK’s EU referendum and the potential implications of a Brexit for the economy. Whatever the individual commentator’s pre-set beliefs, they will likely be able to find some sort of ‘evidence’ to support their view. But the reality is simply that no one can know either the result or how either scenario would play out.

Long term, both the costs and the potential benefits of Brexit to the UK economy are probably exaggerated by commentators and campaigners on either side of the argument.

Remember the reasons for investing

Stock markets can be unpredictable. They move frequently – and sometimes sharply – in both directions. It is important to take a long-term view (typically ten years or more), and it’s important to remember the reasons for investing in the first place.

Investors need to be prepared to view the occasional downturns simply as part of a long-term investment strategy. Historically, the longer you stay invested, the greater the chance of smoothing out investment returns. Of course, it’s worth remembering that past performance is not a guide to what might happen in the future, and the value of your investments can go down as well as up.

Emotions overcome sound investment decisions

Brexit is an emotive subject and one that you rarely hear analysed in a dispassionate way. There will inevitably be times of market volatility. Market falls are a natural feature of stock market investing. During these times, it is possible that emotions overcome sound investment decisions. The important thing is to resist the temptation to change your portfolio in response to short-term market movement. ‘Timing’ the markets seldom works in practice and can make it too easy to miss out on any gains.

The golden rule to investing is allowing your investments sufficient time to achieve their potential. Warren Buffett, the American investor and philanthropist, puts it very succinctly: ‘Our favourite holding period is forever.’

Don’t panic and sell out of the market

Over the long term, investors do experience market falls which happen periodically. Generally, the wrong thing to do when markets fall by a reasonable margin is to panic and sell out of the market – this just means you have taken the loss. It’s important to remember why you’re invested in the first place and make sure that rationale hasn’t changed.

The market implications of a Brexit are difficult to gauge at this stage, and it’s also important to note that a vote for the UK to leave the EU would not be the end of the process but the beginning of a new negotiation phase which is likely to take at least a couple of years. During this two-year period, existing EU laws and regulations would continue to apply to the UK.

Avoid being distracted by ‘noisy’ commentary

No one can predict the outcome of the referendum, and we must avoid being distracted by ‘noisy’ commentary. Even if there is Brexit, it is not clear that there would be significant, permanent investment implications, so it’s important that investors maintain their current view on the UK based on current economic fundamentals.

Recently, the Bank of England (BoE) summarised four decades of research on the net economic benefit of EU membership: the answer was that it was in the range of -5% to +20% of GDP. The net benefit of Britain leaving the EU would be just as difficult to measure, even long after the fact. It is certainly impossible to predict in advance, but the analysis above does highlight some key takeaways for investors.

Past episodes of political uncertainty

We can expect sterling to remain weak for the duration of the campaign. Britain’s reasonably sound fiscal position suggests that gilts would be much less affected, and short-term money market rates are likely to be held down by the BoE’s no-change stance on rates. But, in past episodes of political uncertainty – notably, the Scottish referendum in 2014 – we have seen the yield curve steepen slightly relative to the US, and we could see that happen again if the polls continue to be tight.

Growth and investment is expected to be modestly lower in the first half of 2016 due to the uncertainty created by the vote. But don’t expect this to outweigh more important factors such as growth in Europe and the US and broader sentiment in global markets. Most of these effects should reverse themselves in the event of a Bremain vote. But do not be surprised if sterling ends the year materially weaker, on a trade-weighted basis, than at the end of 2015. And do not be surprised if there is talk of another referendum on EU membership if the June vote is reasonably close.

Broad direction of UK asset markets

In the event of a vote for Brexit, expect these macroeconomic factors to intensify and UK growth to be materially slower than in the no-change scenario. The eurozone would also see a short-term downturn. But, even for the UK, the broader global outlook will be more important to medium-term growth and the broad direction of UK asset markets.

Leaving the EU would no doubt lead to uncertainty in the short term with a knock-on effect on market volatility. But this can be seen as an opportunity too – markets tend to overreact initially which can create opportunities to buy assets at much cheaper prices.

Boosting competitiveness of UK businesses and exports

If the stock market, gilts and sterling do fall initially, they should all bounce back. There is even a view that gilts would perform well, as the BoE might reintroduce Quantitative Easing. If sterling does stay lower, this could be just what the UK economy needs right now, helping to boost competitiveness of UK businesses and exports. The stock market has also tended to rise on sterling weakness, and this pattern might be repeated post-Brexit after an initial bout of uncertainty-induced volatility.

It is also not impossible to see an influx of capital into the UK; global investors might consider a more liberal UK an attractive alternative to the sclerotic eurozone. This could lead to a stronger pound.

Need more information?

Market volatility can be unnerving for investors, but having a global strategy and broad diversification of assets should help to smooth out some of the inevitable ups and downs involved in stock market investing. If you would like to review your particular situation or have any questions, please contact Reeves Financial on 01403 333145 or email areeves@reevesfinancial.co.uk for further information.

INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.

THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.

PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.

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