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Edmond de Rothschild: Why Brexit will only have a limited impact

29 June 2016

Philippe Uzan, chief investment officer at the asset management firm, explains why a Brexit does not signify the breakdown of either UK markets or the domestic economy.

By Lauren Mason,

Reporter, FE Trustnet

Investors shouldn’t flock from UK equities or panic about a complete market breakdown, according to Philippe Uzan (pictured).

The chief investment officer at Edmond de Rothschild says that the firm has made few changes to its equity portfolios and points out that, while markets have fallen, they are not at levels that would cause the team to rethink its investment policy.

Following Friday’s shock announcement that the UK is indeed set to exit the EU, the FTSE 100 slumped by 3.15 percentage points over the course of 24 hours. Since the start of this week though, it has climbed by 2.64 percentage points.

Performance of index over 1week
 

Source: FE Analytics

While this has led many investors to breathe a sigh of relief - with FE Trustnet’s latest poll showing that a majority of participants plan to hold onto their UK equities – Uzan still warns that caution is prudent over the coming months.

“The spike in volatility on June 24 when markets were wrong-footed by the UK referendum result suggests we should be cautious over the short term,” he said.

“Market moves were spectacular but trading generally remained orderly. Earnings in companies with the biggest exposure to the UK will have to be sharply revised lower as the country will inevitably be hit by a severe investment slump.”

“Analysts will, however, struggle to provide precise figures as the situation is unprecedented and its medium term consequences uncertain.”

The chief investment officer says that initial market reactions varied widely depending on sectors, with defensives and interest rate-sensitive stocks significantly outperforming cyclicals and financials.


In terms of region, he points out that Europe endured the greatest losses alongside Japan, which was hit by a boost in the price of the yen. In contrast, emerging markets have best navigated the tumultuous landscape, which Uzan says demonstrates the shift in investor sentiment towards the market area over recent months.

Performance of indices over 1month

 

Source: FE Analytics

We have so far made few changes to our equity portfolios. As far as the global economy is concerned, we think that once the shock waves have subsided, Brexit will have only a limited impact and that economic trends in the US and China will once again dictate events,” he continued.

“European markets are already trading at a significant discount but this could be partly reduced if contagion risk is properly addressed and the probability of a broad agreement improves.”

“As for investment styles, heightened uncertainty and the likelihood the Fed will adopt a wait-and-see attitude suggest a partial rebalancing away from value towards growth. The political calendar in the second half of 2016 is very busy - a new UK government, the search for a coalition in Spain, a referendum on institutions in Italy and the US presidential election - and will drive volatility, a situation that we will continue to strive to exploit tactically.”

The chief investment officer argues that the impending Brexit is unlikely to fuel market volatility across the board - unlike the Greek crisis which was at the forefront of many investors’ minds between 2011 and 2015 – because it is a country outside of the eurozone and will therefore cause fewer knock-on effects in Europe.

Because of this, he says that the main focus should be how to integrate higher risk premiums in markets.

“Additionally, we have observed no major post-referendum disruption and central banks stand ready to intervene with massive liquidity injections. This has been an abrupt about turn for investors, especially as there is no real precedent and no visibility as yet on what shape future relations between the UK and the EU will take,” he said.


“Brexit is highly probable but could yet be put off: there are so many scenarios as to what will happen after article 50 is officially triggered.”

While many investors are likely to be bearish on Europe at the moment given its high level of geopolitical risk, Uzan points out that the continent has also been experiencing tailwinds such as a drop in unemployment and the fact that the EU has already shown it is able to reform.

After the threat of a Grexit, for instance, banking supervision was handed over to the ECB which ultimately led to the inception of a European deposit guarantee fund.

In fact, Europe has been Edmond de Rothschild’s largest regional weighting since the start of 2015, although the firm has trimmed its overweight over the last two months and substituted this for US dollar exposure.

Because of the belief that central banks will now adopt further acommodating monetary policy, Uzan says that it is unlikely the Federal Reserve will hike rates until at least Q4 this year.

“Markets have fallen sharply but have not yet gone to the sort of extreme levels that would make us reconsider our investment policy,” Uzan said.

“We are more than ever on the look-out for any short term opportunities and also ready to adapt our medium term investment approach.”

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