Brexit and recent market performance

With news headlines dominated by the United Kingdom’s vote to leave the European Union, we bring you an update on recent market performance following Brexit.

Dominating the news headlines this week is the United Kingdom (UK) vote to leave the European Union (EU).

Our Investment Team has been working to bring you a considered view of potential impacts to investments following Brexit.

Brexit and recent market performance

The recent referendum outcome has no immediate consequence to economic linkages between the UK and the EU.

The vote may lead to an exit from Europe’s free trade area, but the process for bringing this about will require multilateral negotiations between UK, the EU, and 50 other countries that are part of the World Trade Organization. This will not happen overnight. It may take anywhere from 2 to 10 years to resolve such matters; Greenland went through this process and it took about 3 years. Over this period, it is quite probable that this will fuel heightened tension within and across the countries that comprise the EU. In brief, this event adds significant and prolonged uncertainty to an already fragile economic environment.

What is the possible impact on economic growth?

The UK represents about 3.5% of World GDP. A recent study by the International Monetary Fund (IMF) report a potential fall in UK growth by 1% (best case) to 6% (worst case). Hence this implies a first order worst impact on World GDP growth of -0.2%; this suggests the impact on the Australian economy is likely small. Furthermore we note that the UK represents only about 3.4% of Australia’s trade with the world. These big picture statistics mask what may be significant and material distortions for various economic segments (agriculture, pharmaceuticals, and financials) that could be most affected.

The uncertainty resulting from these developments have clearly rattled financial markets.

There has been a general flight to safety implying that equity markets around the Globe and especially those in Europe and in Emerging Economies have fallen sharply. The British Pound has fallen in value and the Australian Dollar also has lost ground to the US Dollar. Investors have bid up bond prices resulting in lower yields; credit instruments have fallen in value. Central Bankers have responded by continuing to pledge their support for stability and willingness to inject liquidity as required.

Will this persist?

As we have suggested, the expected impact on world growth is not material, and hence we do not expect current events to lead to a prolonged adverse performance of equity markets. We believe that it is now less likely that the FED will raise rates and hence that yields may fall further. The uncertainty from the recent events and what may unfold are not however likely to dissipate any time soon. Hence this dark shadow will continue to loom over asset markets for some time.

Crowe Horwath will continue to maintain an open dialogue with you about market events. Should you have any further questions regarding this update, please don’t hesitate to contact your local advisor.