By Richard Buxton
The UK has voted to leave the European Union. As the initial reaction in financial markets has shown, there is no merit in pretending that for investors and companies this is not, by some margin, the worst of the two possible outcomes of the referendum.
We had expected the result of the vote to be close, but our conviction was nevertheless that the status quo would prevail.
The biggest sadness of today is that it is reasonable to assume that the UK will quickly enter a period of economic recession, the key reason why we believed the outcome would be different from what has materialised today. It is, in effect, likely to be the first ever “DIY recession”, as George Osborne prophetically called it.
It is difficult to say at this stage what action the Bank of England may take, but it is not impossible to imagine that it may quickly cut interest rates. Restarting the programme of quantitative easing – a feature that has been absent from the economic landscape for some three years now – also looks a possibility. At the very least, the central bank is likely to indicate its preparedness to take such action.
Immediate reaction in markets
The oil price declined immediately by around 5% as the likely result of the vote became clear, suggesting expectations for a marked decline in global demand. Other early indicators included declines in the Australian, Hong Kong and Japanese equity markets, which were still in session as the results were being announced. Bond yields immediately declined (prices rose), as investors began to seek perceived safe havens.
We believe that the prospects for domestically-focused UK businesses are clearly the bleakest of all. FTSE multinationals will, on a relative basis, almost certainly perform better than their domestically oriented peers as the weaker pound will support overseas earnings when translated back into sterling.
Nevertheless, investors should now brace themselves for an unpleasant period of relatively indiscriminate selling as funds aim to meet redemptions in conditions where liquidity may be more limited than usual.
In terms of international markets, there seems to be a real possibility that the result could contribute to tipping the US economy into recession.
Policy response and medium-term view
Looking further ahead, it seems inevitable that the UK and European economies will face a period of two years of uncertainty, as the UK attempts to negotiate how to extricate itself from the European Union, while maintaining access to European markets.
During this period of uncertainty, inward investment is likely to remain at best muted, as both international and UK businesses consider their options for future capital expenditure and hiring.
The result, in our view, also has potentially very serious implications for the future of the European Union itself; a break-up of the broader union has today become a distinctly greater possibility, and we would not be surprised to see amplified calls from, for example, the Netherlands, Sweden and Denmark to leave the EU.
In terms of the UK political landscape, David Cameron’s position as prime minister will now inevitably look strained, notwithstanding his earlier assertions that he would remain in post regardless of the outcome of the vote. He may nevertheless survive, as it may be felt that he is best placed to negotiate exit terms. Chancellor George Osborne’s current position is now similarly under threat, while the likelihood that he will become Cameron’s successor has all but evaporated.
Meanwhile, the result of the vote in Scotland shows a very different picture from that of England, with voters north of the border choosing resoundingly to remain in the EU. As such, the likelihood of a break-up of the United Kingdom has increased significantly.
Emotional reactions
Within equity markets, as ever at times of market stress, emotional reactions will mean that price falls will overshoot; this is the very nature of stock markets. The gold price was one of a very small number of bright spots as the result became clear; it immediately broke convincingly through the US$1,300/oz barrier, as investors looked for safe havens.
It is hard not to feel disappointed at this result, which we know is likely to result in a difficult period for UK equity investors. As ever, we will do everything in our power to help our clients to navigate these market conditions; any investment decisions we take will be made with careful consideration.
Richard Buxton is head of UK equities and CEO at Old Mutual Global Investors
