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30.06.2016 CIO Market Watch – Life after Brexit
With Maximilian Kunkel, Cross-Asset Strategist, UBS Wealth Management


Deeper dive

Life after Brexit

The fallout from the surprise UK referendum result continues to reverberate around the world, although as the week draws to a close there is sense that markets are finding their feet. Reassuringly, they have settled around levels we expected before the referendum, and there are no signs yet that this localized event could become something more global.

Its economic consequences for the UK are as yet unknown, but our sense is that activity will grind to a halt in the short term, and maybe even go into reverse as businesses and consumers react unfavorably to the rise in uncertainty. The political consequences, by contrast, are clear. A vacuum has opened up with a powerless prime minister holding the fort until a successor arrives. And in the opposition party, plans are afoot to unseat their leader. The good news is that the successors should be in place by September, which should enable the political establishment to focus on the task at hand.

At this stage, it is hard to imagine that the result of the referendum will be overturned; an “exit from Brexit” seems unlikely. To be sure, there are many events that could bring it about, but to our mind it is more sensible to think about what comes next. While little is known, our sense is that the UK will look to broker a deal along the lines of a European Economic Area arrangement, similar to Norway’s. If this is the case and the plans are announced soon, it should provide some clarity to businesses, investors, and consumers in the UK.

The economic reality of such a deal is that very little would change, so it should lift the veil of uncertainty and enable the UK economy to return to some semblance of normality. The hit to economic activity wouldn’t be reversed, but neither should it persist for long, allowing investors to turn their attention away from the UK and focus on the bigger picture.

And this bigger picture is one where the US economy continues to show resilience. Some signs of easing in the pace of hiring and yet another unwelcome hit to markets are likely to keep the Federal Reserve in cautious mode for the time being, but unlikely to lead to a change in direction. And in Asia, which feels off the radar with all eyes on Europe now, the story remains one of stabilization, with pockets of strength emerging. For Europe itself, caught in the eye of the Brexit storm, the economy is unlikely to escape unscathed, but we shouldn’t become too fatalistic as the domestic recovery, supported by an active central bank, will continue.

Brexit has presented investors with yet another hurdle to overcome, and emphasizes the need to maintain a diversified portfolio. Political risk feels higher today than it has for some time, and it isn’t going to get any easier over the next 18 months. But we should also remember that volatility often presents opportunities that we should not shy away from in a world where economic growth is set to continue.

Mark Haefele

Global Chief Investment Officer
Wealth Management

Dean Turner

Economist


Bottom line

Brexit has rocked the UK political establishment, which now faces a period of soul searching. Economic growth in the UK will be hit, but our sense is that the

broader global ramifications will be less severe. Thus, recent market volatility offers opportunities for investors to investigate in the context of a diversified portfolio.