Brexit - Immediate Market Reaction

Unexpectedly the British electorate have voted in favour of leaving the EU. I thought in the light of this it might be helpful to outline the market reaction and what may be likely outcomes over the longer term.

Markets crave known facts and fret about variables, seeing potential risks in all unknowns. With this vote, an enormous portion of the map is now draped in uncertainty. Unsurprisingly global markets have reacted with a wild descent. The British pound plummeted 11% against the US dollar, reaching levels not seen since 1985, before recovering a bit, as investors rushed to 'safe haven' currency such as US dollar and Japanese yen. The Irish stock market was down 10%, the UK FTSE 100 was down 8%, the French CAC was down 7% and the German DAX was down 8%. The Stoxx Europe 600 Index sank 6.6% as of 9.50 am in London, heading for its biggest decline since 2008. Oil prices fell more than 6%, while gold, considered a safe haven in uncertain times, jumped by 8%. All sectors were hit, though banks and financials seem to be hardest hit. As I write this the markets are continuing to fluctuate.

The Brexit vote is likely to resonate as a sign that major democracies are increasingly vulnerable to influence of populist political movements that curry favour by demonising immigrants and external forces - low wage workers from abroad and officials in Brussels. The success of the campaign may cause markets to ascribe a higher probability that Trump will be elected president in the US, and it also increases the markets perception of an EU break-up risk. Political risks have increased and with elections due soon in France and Spain, not to mention recent surprising electoral results in Italy (Rome and Turin mayoral elections), if another Euro crisis were to emerge, Europe may lack the political cohesion to address it. Further separation could fragment the common market, bringing the demise of a 60 year old project of European harmonisation. Few expect breakup, but whatever the risks were before, Britain has just increased them.

In the shorter term borrowing costs are likely to rise for heavily indebted nations, including Greece, Italy and Portugal as investors demand extra inducements to put this money into riskier locales. The Bank of England have promised £250 bn to calm markets in the wake of the vote. It is expected by many that the Bank of England will have to cut interest rates in the near future to halt a plunge in the pound. The European Central Bank have also promised to provide extra liquidity to protect the financial markets. Some investment managers are forecasting that the UK will slip into a mild recession. As the UK accounts for 17.5% of Irish exports, this will have a knock on effect for Irish economy. However, Ireland’s exports tend to be in defensive sectors like food and beverages, and pharmaceuticals which weather recessions well. Irish exporters will have to deal with the loss of competitiveness from sterling’s depreciation. However, in time they should be able to push through sterling price rises as the depreciation leads to generalised upward pressure on UK CPI inflation. A key point is that there will be no fundamental change in trading arrangements until the end-of the two-year EU exit period under the Lisbon Treaty.

In the midst of this uncertainty it is important not to listen too much to what I call 'short term noise'. Your pension / investment is a long term investment. There will be days when it appreciates in value and there will be days that it falls in value. The normal pattern of investment in stock market investing is small common upward advances interspersed with relatively infrequent sharp falls in price. Very often the sharp increases in share prices come close after the steepest declines. Timing the market is difficult, and in my opinion, impossible.The key is to ensure you have a diversified investment portfolio with the appropriate split of defensive assets and growth assets to match your risk profile and investment goals. Furthermore, for those of you who contribute regularly to a pension or savings account, the market volatility offers you an unexpected advantage -by investing on regular basis into your pension / savings, you are buying into the market at regular intervals, regardless of its level. All that steady euro cost averaging, year after year, means that you are never buying a big stake at a market high (or, it is true, a market low) It should be remembered that in a bear market (ie when shares are falling), you are buying your investment units at a discount, and profits are made, although few see it at the time. Whether markets go up or down in the short term is likely to be insignificant, investing is for the long term and investment plans should reflect this. 

I anticipate  a period of extended volatility over the next few months as this Brexit shock plays out, coming on the heels of concerns about global economic growth, fears about the effectiveness of monetary policies, China slow-down etc. Attention will turn to how to dis-entangle Britain from Europe and what the new trading relationship will look like. Please feel free to contact me with any concerns or questions you may have. 

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Gavin Gilmore trading as Gilmore Insurance & Financial Services is regulated by the Central Bank of Ireland.
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