Britain votes to leave the EU
More market volatility expected
Sadiq S. Adatia
Opinions as of June 24, 2016
FLASH MARKET UPDATE
After nearly three years of increasingly contentious debate, the British public voted to withdraw from the European Union today – sending financial markets into a tailspin and raising uncertainty about the EU’s future.
British Prime Minister David Cameron accepted responsibility for the outcome. It was his decision to call the referendum to appease a growing element within his Conservative party that opposed what they (and now a large segment of the population) see as the growing concentration of economic and political power in Brussels.
The British are gambling that even though their economy is doing relatively well, they will be better off outside of what the British media likes to the call the “Euro mess.” But it will be some time before they’ll know if their bet will pay off.
In the meantime, financial markets clearly don’t like the odds, with Euro STOXX 600, a bellwether for both U.K. and Eurozone equities, falling almost 10% (in euros) during the run up to the vote.And Bank of England Governor Mark Carney has warned that the country will now have to absorb a number of economic blows, including a possible recession.
The vote also comes at a time when Britain’s current account deficit is close to a post-war high. If capital now starts to flee the country, in the near term it will drive down the value of the pound which had already been falling.If this happens, Carney said it could trigger inflation, making life more expensive for the average person and potentially forcing the BOE to raise interest rates.
MORE TROUBLE AHEAD FOR THE EU?
The EU is already struggling through a period of slow growth. And its fragile economy could suffer further if the British decision raises fears that the EU will unravel, causing business confidence to dry up and an outflow of capital to safe havens.
There could also be negative implications for the global economy, with G7 leaders warning that the U.K’s. exit from the EU could reverse the trend towards greater global trade and investment and the jobs it creates.
The future of the EU will be debated in a number of European general elections next year, and Britain’s move to go it alone could galvanize anti-EU political forces. A number of countries have also no doubt noted that Cameron was able to negotiate concessions from the EU after the referendum date was set. They may now use that same strategy to negotiate their own side deals, potentially further weakening the EU.
WHERE DO WE GO FROM HERE?
We expect the EU to calm the water by reassuring financial markets that it has a credible post-referendum strategy in place. It will also have to engage the U.K, which under treaty, has two years to negotiate a withdrawal agreement.
If a deal cannot be reached all treaty obligations would lapse, which would be damaging for all parties. This is especially true for the U.K., with exports to the EU accounting for 13% of its £1.8 trillion GDP, while the EU’s exports to Britain represent just 3% of its £11.7 trillion GDP.
Due to the U.K.’s dependency on EU markets, Britain will likely attempt to hammer out a comprehensive free trade agreement with the EU, such as Turkey has done. Or like Switzerland, it could try to negotiate a series of separate deals giving it access to European markets while leaving it with control of its own border and economy.
But negotiating a new financial relationship in the heated post-referendum atmosphere will likely be a very long and difficult process.
OUR TACTICAL APPROACH - POST REFERENDUM
In the months leading up to the referendum, we lowered our exposure to British and Eurozone equities in the belief that volatility would increase as we headed into the vote and afterward if Britain voted to leave.
Still, we have a strategic view that includes investing in Europe, but only when we think valuations and risk have come back into line. That could take a while or happen quickly. In either case, we employ a number of tactical tools that will enable us to fine-tune our investment views based on market conditions.
For now, we believe investors should avoid getting caught up in all the dire commentaries about Britain’s and Europe’s future. Instead, be patient – opportunities to invest will emerge as the two parties settle their divorce and come to a new arrangement.
This commentary contains information in summary form, for your convenience, published by Sun Life Global Investments (Canada) Inc. Although this commentary has been prepared from sources believed to be reliable, Sun Life Global Investments (Canada) Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of Sun Life Global Investments (Canada) Inc. and/or its affiliates. Please note, any future or forward looking statements contained in this commentary are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this commentary.
© Sun Life Global Investments (Canada) Inc., 2015. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.