According to IOOF Investments, the UK vote in favour of leaving the EU highlights the importance of diversification in managing assets in Australia. Chief investment officer Steve Merlicek comments.
Firstly, all the experts – the political and business elite and even the bookmakers – got it wrong. Markets ran up and rallied ahead of the Brexit vote and even with the resulting declines after the vote, some markets were about even for the week.
- Certain sectors such a banking/financial stocks were hit hard whilst other stocks, which could be beneficiaries of a weaker pound, fared better
- Gold stocks also rallied as gold went higher, whilst the pound and euro dropped – in the case of the pound to a 30 year low against the USD
- Bonds rallied – with 10-year US treasuries (bonds) rallying to 1.5 per cent
- With the risk on trade occurring, the Australian dollar dropped around 2 cents against the USD.
There will always be geopolitical events in markets and Brexit reinforces the importance of diversification in creating portfolios and managing assets.
Brexit does create a lot of uncertainty and noise by economic and political commentators – and markets hate uncertainty. Further, are there follow-on events such as the breakup of the United Kingdom if Scotland leaves or other countries seek exit from the EU, currency instability and so on.
To counter the above arguments it can be said that:
- There will be a policy response by authorities (as in the past) which will tend to lower interest rates and raise system-wide liquidity, though we are coming to the natural limits of some of these policies
- Whilst the UK is important (it’s the fifth largest economy) in the scheme of the world wide economy, the United States, China, Japan, Germany are much more important
- With the UK itself, a weaker pound will help export industries and boost economic activity.
It should be remembered that there are many countries outside the EU who prosper. Further, countries such as Switzerland and the Scandinavian countries have negotiated individual deals with the EU and still do well. It will also free up the UK to do deals with other countries outside the EU and because the UK runs a deficit with the EU, most, if not all EU countries, will still want to deal with the UK.
A buying opportunity or time to go to cash?
Finally, if UK markets get hit hard as a result of Brexit, it probably is a buying opportunity. London and England have a number of comparative advantages that are difficult to replicate in the rest of Europe (as reflected by the influx of inward migration into the UK).
In a situation such as Brexit, we suggest investors go back to first principles:
- In terms of stocks – if good quality stocks (that have little to do with Brexit) are affected, then it is probably a buying opportunity – because the longer term prices will be decided by earnings, yield, cash flow and other fundamentals. If anything, the search for yield will increase – especially as official interest rates are forced down further
- It should be remembered that markets often tend to overshoot – both on the upside and downside. There will be opportunities in currency markets and regions as we see big movements in currencies and hence the price we pay for a whole country’s assets
- For bonds and the issuance of debt – maybe the bubble just gets bigger and bigger.
Commentators such as Alan Kohler say this is just another good buying opportunity, whilst others say that this is just the start of something larger, with greater knock-on effects and continued uncertainty.
In the end analysis, Brexit has shown the benefit of being diversified, having sufficient cash levels to take advantage of opportunities, and how the experts can get it wrong.