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Brexit uncertainty: keep calm and carry on

As the EU referendum looms and the polls suggest an incredibly tight race between Leave and Remain, market price movements are reflecting the potential closeness of the vote on 23 June. Most financial institutions had previously had Remain as their base case outcome. There has been a further weakening in sterling and the FTSE 100 Index has dipped below the 6,000 support level, while nervous investors seeking safe havens have spurred gold prices upwards and pushed 10-year German bund prices higher, with yields having briefly slipped into negative territory and are now hovering around zero.

While ‘Brexit’ is without doubt the issue that is front of mind for investors, there are a number of other factors in the background dogging markets. These include renewed fears around the Chinese economy after data was released this week showing a slowdown in private investment in China in May, which suggests low confidence and may indicate that China’s last round of stimulus has proved short-lived. China was also knocked back again this week from having its mainland A-shares included in the MSCI Emerging Markets Index, a move that would have resulted in significant investment flows into the country.

But also on the minds of professional investors this week have been a series of key Central bank meetings, including the US Federal Reserve’s (Fed) Open Markets Committee and the Bank of Japan (BoJ), both of which kept their current policies on hold. In the case of the Fed, this was widely expected but in the post meeting press conference, the bank’s Chairwoman Janet Yellen acknowledged that its decision to keep interest rates on hold for the time being was partially down to the UK’s EU referendum which she said “could have consequences in turn for the US economic outlook.”  With bank officials having recently talked up the potential for further rate hikes this year, Yellen struck a more dovish tone by acknowledging the bank needs to make sure there is “sufficient momentum” before lifting the cost of borrowing.

There were higher expectations that the BoJ might announce additional measures, such an expansion of its Quantitative Easing programme, as it battles to achieve its inflation target and arrest the strengthening of the yen which is hurting its exports. However, in the event the BoJ kept policy on hold prompting a further surge in the yen and causing 10-year Japanese government bond yields to plunge deeper into negative territory.

Caution in uncertain times

In these uncertain times including ‘Brexit’, concerns about China, Central bank pondering and the theatre of the US Presidential elections, continued turbulence in financial markets can be expected. Our investment team continues to position portfolios cautiously, as they have done long before the EU referendum campaign, with overweight exposure to absolute return funds and cash and, within UK equities, a preference for funds focused on larger company shares.

There is clearly a lot of anxiety currently factored into the equity markets, which could either turn into a knee jerk sell-off or unwind into a relief rally in the aftermath of the vote. There are risks at this stage for investors taking evasive action either now or immediately after such a binary event as a referendum. However, as we have previously pointed out, whatever the impact on the UK domestic economy from ‘Brexit’ (and no one really knows), don’t confuse the UK stock market with the domestic economy. Over 70% of the earnings of the FTSE 100 are derived outside of the UK, typically in dollars – so, whatever the immediate and indiscriminate response from the markets, many of the FTSE 100 businesses might actually see a temporary buoyancy from the impact of favourable exchange rate translation from overseas earnings in dollars into sterling profits and dividends. In the event of a ‘Leave’-induced slide in share prices, long-term investors need to ‘keep calm and carry on’.

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