Brexit: What Consequences?

In the short term: a transition phase with additional volatility began following Britain’s surprising vote to leave the EU. Other important political events are weighing on the financial markets. Nevertheless, we are making no changes to our investment strategy this month because the markets were swift to price in these uncertain factors.
 

We revised our economic forecasts after the Brexit vote

The historical decision to leave the European Union will have a negative impact on economic growth in the UK and in the euro area owing to the direct correlation with international trade, a period of uncertainty, translating into a freeze of investment decisions (including in real estate), and finally, a tightening of monetary and financial conditions.

We have substantially revised down our growth forecasts for the United Kingdom for 2016 and 2017, to 1.4% (from 1.7%) and to 0.7% (vs. 2.1%), i.e. in total, 2 growth percentage points lower by 2018. The impact will be more limited in the euro area (a 0.4pt decrease in growth).

There is no quantifiable impact on the US or on emerging countries.
 

Impact on monetary policy

To counter the risk of a recession, the Bank of England will lower its official rate by 50bp (currently at 0.50%), inject liquidity, and probably extend its (former) Quantitative Easing programme (£50bn initially). The next BoE meeting is scheduled for 14 July.

The financial markets no longer expect a hike in Fed rates this year or in 2017. This is exaggerated in our view, and could lead to a “repricing” of the risk of an increase in US rates. Solid economic data might lead the Fed to normalise monetary policy.

No change from the ECB, which might extend its QE programme in September.
 

Divergence in reactions between market segments

During the two days following the Brexit vote, there was a noticeable decline before stock markets picked up overall (and in the UK), and returned to above (or close to) previous levels. A notable exception was the financial sector (especially banks and listed real-estate) which did not pick up overall.

However, bond markets reacted differently: rates in Europe fell to record lows and did not climb back up. This was the case for the UK and the core Euro area. However, spreads in the periphery European countries widened, reflecting the higher risk premium sought by the markets. In Spain, this movement was not as visible, because of the outcome of the elections in which mainstream  parties did relatively well.

This phase of growing volatility on the stock markets and a flight-to-quality move could continue over the summer due to downward revisions to growth forecasts in Europe and the pricing in of a political risk premium. Brexit negotiations between the UK and EU have not yet begun, but they will be tough and will take a long time, in the context of a fragmentation risk. Finally, there is a packed elections agenda: a referendum on the Constitution in Italy (September), a re-run of the presidential election in Austria (October) and the US elections (November). Next year, the French and German elections will be held.
 

The search for yield will boost stock markets

In the medium term, the trend in the stock markets will depend on profit and dividend growth, which should remain positive in our view. Our main scenario is that the global economy will continue to grow moderately, but in positive territory nonetheless. Profit margins (excluding the US) have significant rebound potential, particularly thanks to the oil sector, with the barrel of oil having stabilised at around $50.

In the context of a moderate upward trend in profits and in stock markets generally, dividends still represent a sizeable proportion of total returns from equity investments.