After months of uncertainty and market volatility, the UK voted to leave the European Union by 52 per cent against 48 per cent to remain. The Prime Minister David Cameron, who campaigned vigorously for the UK to remain in the EU, stepped down and we have a new leader in Theresa May. The formal request from the UK to leave the EU, Article 50, has not yet been triggered and the timing remains unclear. The focus for investors will be the reaction of markets, and the short and long-term economic implications.
Investor uncertainty is understandable and markets will remain volatile. However, the initial reaction in markets is consistent with our expectations prior to the vote. Markets are functioning in an orderly manner at this point, with those companies with overseas earnings benefiting from the significant fall in sterling. It is worth remembering that the impact on global economic growth is not as significant as the global financial crisis of 2008. The referendum is about the UK's relationship with Europe, and will only have a small impact on global trade.
The vote to leave the EU has led to a downgrading of near term UK growth expectations. We expect a slowdown, although a recession should be narrowly avoided. Stagflation looms as the inflationary impact of a weak sterling comes through. However, at just over 4 per cent of global gross domestic product, the UK is not significant enough to derail the world economy. Easier monetary policy will also help soften the blow and global growth is expected to be only slightly lower than that anticipated before the referendum result. Despite this, we recognise the increasing tail risks following the UK’s decision. Political risk has clearly risen within Europe as the UK experience could be repeated elsewhere.
As the markets continue to process the outcome of the referendum, it is clear that the implications are complex and long lasting. The wide range of 2017 UK GDP forecasts highlights the high degree of uncertainty. The medium-term global economic and policy outlook remains unclear, and political risk adds an additional ambiguity. The UK market has punished domestic earners, with the larger more international companies significantly outperforming since the vote. Sector dispersion has been considerable, and volatility has remained elevated. Corporate earnings are in focus, with currency volatility a significant factor for international earners; fears that reducing corporate and consumer confidence add to the potential for disappointments.
We continue to see a lack of value in bonds, particularly with the anticipated pick up in inflation and prefer to diversify into alternative assets such as absolute return. Where we hold cash, we view it as a defensive asset, to provide us with liquidity to take advantage of any unwarranted weakness. Equity markets are likely to remain volatile, but should be supported by monetary policy. The outlook for UK commercial property has not been helped by the vote, but we believe that the attractive income flow should underpin values. We maintain that diversification will be crucial in navigating markets over the next few months as our interpretation of the political and economic landscape evolves.
Kate Rogers is head of policy at Cazenove Charities