The EU Referendum result is a political earthquake for the UK, with important economic consequences that will hang over the country for years, if not decades. But the impact for other countries and markets will depend on how close they are to the epicenter.
There is more to the life than Brexit – at least for financial markets. Now more than ever, investors need to take a global view.
We view the global economy as being at a crossroads, with the future even more uncertain than usual. A combination of a structural deterioration in potential growth and the overhang from the global financial crisis had already dampened growth and dragged down long-term interest rates.
Now yields have fallen further in the wake of the Brexit vote, with investors starting to question whether 2016 will see any US rate increases at all.
We believe the global economy can and should continue slowly to recover and US rates can eventually start to move up again. But for that to happen, the broader economic and political fallout from Brexit has to be containable, particularly in Europe and US productivity and corporate earnings need to start to recover.
These two developments, along with a broadly stable dollar, would boost confidence in the recovery and help support markets as we move towards 2017. But central banks have limited room to respond if events do not follow the script.
There is no shame in having few high convictions in this environment. It makes sense for investors to seek more balanced portfolios, think global and lower their expectations for future returns.
Key considerations for investors this quarter include:
1). Life after Brexit – expect short-term volatility but European assets are still moderately well supported. Investors are likely to remain in a ‘wait and see mode’ while UK corporate investment, the value of the currency, and Europe’s economic growth are expected to be affected by the uncertainty.
2). Flat curves and negative yields – investing in a lower-for-longer world. While yields may not seem attractive, it is likely that they can continue to move lower given the shift in risk sentiment and the economic outlook for the UK and Europe.
3). Investing in a maturing US economy and the case for alternatives. A solid economic foundation and a brighter outlook for earnings make US equities an interesting spot, but investors should focus on the cheaper parts of the market and on income opportunities. It is important to focus on strategies that will be able to outperform the market when the next recession does eventually arrive.
4).What next for commodities? Falling commodity prices over the past few years have been viewed as symptomatic of broader economic malaise and a shaky outlook for Chinese growth and demand. But if the market is now past its worse, this would have important implications for commodity producers, emerging markets and the medium-term inflation outlook.