According to media reports this afternoon, the United Kingdom (UK) has voted to leave the European Union (EU) – an unprecedented move in economic and investment market terms – which is sure to cause short-term market volatility and concern for investors.

UK votes to leave – what next ?

Because this situation is unprecedented, there is no verified or tested procedure for an EU exit.

This uncertainty means that whilst we cannot be definitive as to what happens next, it is plausible that article 50 of the EU Constitution (the law governing the process of divorce form the EU) will be triggered, which will kick-start a formal two-year process to determine the terms of the UK’s exit, including the shape of it’s future access to the single market (of the European Union).

There is also likely to be mounting pressure on Prime Minister David Cameron to resign.

Economic Outlook (UK)

There is likely to be negative short term impact on UK economic growth because of:

1. Increased uncertainty and reduced confidence depressing private consumption and fixed investment;
2. Increased risk premia in UK bond markets and potentially higher borrowing costs; and
3. Increased uncertainty, risk aversion, and possible higher funding costs in the UK financial sector.

Note: A weaker pound is likely to support exports and the Bank of Englad may cut interest rates, mitigating the overall adverse impact.

Investment Market outlook (UK)

With regards the likely impact on the UK financial market, in the short term investors can expect:

– Shock to investor confidence and increased UK asset price volatility;

– Further declines in the pound, adding to the 5% depreciation versus the Euro YTD;

– Downward pressure on UK equities, especially financial sector stocks and those most reliant on EU migrants (e.g. construction, hospitality). Less pressure on UK companies with large foreign exchange (FX) earnings;

– Modest upward pressure on Gilt yields is possible owing to increased uncertainty, higher risk premia and the prospect of higher inflation due to the weaker pound (although initially yields could fall due to a flight to safety);

– Upward pressure on UK corporate bond yields owing to increased uncertainty and the worsening short term growth out;look – as with equities, the financial sector is most exposed;

– Modest declines in UK house prices are possible, owing to reduced buyer confidence and a possible uptick in unemployment;

Impact on Europe

With regards the economic outlook for Europe, there are likely to be modest direct impacts:

– European companies with significant UK exposure and assets may cut back on investment until uncertainty about the UK’s future EU engagement eases;

– Uncertainty may also have some negative impact on EU trade with the UK;

– If the adverse economic impact looked significant, the European Central Bank (ECB) would likely expand it’s asset purchases, reducing the risk of a worse-than-expected economic return;

With regards the impact on European investment markets:

– Short-term pressure on equities, especially for European comanies with significant UK revenue, trade and investment exposure, and particularly so if the Euro rises;

– In bond markets, perceived safe-haven yields may compress while corporate bond yields and spreads may increase – as with equities, the financial sector is most exposed;

– In the longer run, the UK leave vote could bolster other Euro-sceptic movements, raising concerns about the wider EU project – this would be most negative for peripheral country assets;

How to manage this volatility ?

From time to time, equity markets experience heightened, event related volatility – this is nothing new – and therefore we remind investors that:

– Volatility is a normal part of long-term investing;

– Avoid being swayed by broad sweeping sentiment of the herd and irrational responses (fear / greed);

– Long-term investors are usually rewarded for taking equity and overseas market risk;

– Market corrections can create attractive opportunities; and

– Active portfolio management can help navigation during periods of increased volatility.

Source: Fidelity International

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