Asset Allocation July 2016

05 Jul 2016


  • Risk assets quickly rebound after UK referendum
  • Safe havens have remained in demand
  • UK referendum a regional shock…
  • … with global implications for monetary policy
  • Challenging investment climate


The main event this past month was obviously the EU membership referendum in the UK. Most analysts, including us, had expected a majority of voters to support remaining in the EU, so the result came as a surprise. Accordingly, risk assets sold off and safehaven assets benefited. However, market developments since the referendum have been interesting. Risk assets have rallied from their lows. US, European and emerging market equities have recouped most of the referendum induced losses. Japan is still lagging as the Japanese yen has appreciated to a two-year high. UK equities are a mirror image of those in Japan; they are now higher than they were before the referendum as the British pound has fallen by close to 10% versus the euro.

While risk assets have mostly recovered, the bid for haven assets has persisted. German 10-year yields have turned negative, while US yields are close to their record low. Gold has surged. We think risk asset markets may be complacent. The global economy and the outlook for corporate earnings were not strong before the UK referendum and political uncertainty has increased significantly. We continue to regard the investment climate as challenging for risky assets.

The British referendum: a regional shock

The long-term consequences of the UK referendum outcome are difficult to assess at this point. In our view, it all depends on the level of economic integration between the UK and the EU after the UK exit. In the second half of this year and next year, we foresee a recession in the UK, albeit not a deep one. We think the economy will shrink in the final quarter of this year and the first quarter of next year. This would have a profound impact on the annual growth rates for this year and next. We have cut our forecast for this year from 1.9% to 1.5% and for next year from 2.4% to 0.0%. We expect growth to suffer as business investment drops with companies putting spending on hold in a climate of heightened uncertainty and unpredictability. We also foresee a slowdown in consumption, fed by the uncertainty and weaker sentiment as well as by falling house prices. Sterling’s drop should boost inflation, curbing consumer spending power.

The eurozone economy could be impacted mainly through the sentiment and financial channels. Financial contagion has so far been limited: equity prices have bounced back quickly; risk spreads and yields on ‘peripheral’ sovereign bonds rose before the referendum, but have since come down.

It is only the spreads and yields on high-yield corporate bonds which are still somewhat higher than before the UK referendum. The weakening of the euro has actually eased financial conditions. We will have to wait and see to what extent business and consumer sentiment will be impacted. For now, we have cut our growth forecast for
the eurozone for this year by a notch to 1.5%. For next year, we have trimmed our forecast by 0.4 percentage point to 1.4%. This should have hardly any impact on inflation, which we see rising gradually to 1.3% at the end of next year.

Without global financial contagion, we expect a British exit from the EU to have little impact on the rest of the world. Growth in the US could be slower in the last quarter of this year and the first quarter of next year, but in our view, this will have hardly any effect on the annual growth rates. Japan could suffer from the appreciation of the yen, which has acted as a haven in Asia. We have not changed our emerging market outlook: we foresee a further slowing in China and relatively modest growth in other Asian economies. We expect the Brazilian and Russian economies to stabilise, although in Brazil, any recovery should be shallow given the headwinds from fiscal austerity and the credit cycle.

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