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Markets got the biggest shock from the Brexit vote since the financial crisis of 2008 and now face months of uncertainty, say Robeco’s portfolio managers for the major asset classes.
Britons stunned the world by voting 52% to 48% to leave the European Union in an historic referendum, causing the resignation of the British Prime Minister David Cameron. The pound dropped to its lowest level against the US dollar since 1985 on the news on fears over future trade after leaving the Single Market, a possible recession, and years of discord and uncertainty.
By 8:00h London time, sterling had fallen over 8% against the US dollar to USD 1.33 and over 7% against the euro to EUR 1.21. The yield on the 10-year British gilt dropped by 30 basis points, and the UK’s FTSE 100 equities index fell 9% when it opened.
“Markets had been expecting a Remain vote, which means that this comes as a nasty surprise,” says Lukas Daalder, Chief Investment Officer of Robeco Asset Allocation. “This will lead to a lot of volatility and uncertainty in the days and weeks ahead, with risk-off pressures at first taking the upper hand.”
“Rather than focusing on this short-term volatility, we prefer to look at the outcome of the situation once the smoke lifts. A recession in the UK looks likely, due to the decline in investments taking place and uncertainty keeping consumer spending subdued. As for Europe, much will depend on the break-up tensions rising, as well as the negative impact of producer confidence. The most likely outcome is weaker growth, but not a recession. As for the US, the spillover should be limited.”
‘The markets can and do overshoot, so selling at all costs is not desirable’
“Based on these assumptions, we think a medium-term correction of 10% in European stocks is to be expected, while a decline of the pound against the US dollar in the order of 15% is likely. But in the short run, markets are definitely going to overshoot that. Despite the low-yield environment, we expect government bonds to act as safe havens once again, while credit spreads are set to rise.”
“We are looking to reduce this risk position, but not at all costs: the markets can and do overshoot, so selling at all costs is not desirable. We still have a slight overweight in risk-terms in our portfolios, but this is hedged by a short position in the British pound. On balance, we expect the impact on our multi-asset portfolios to be muted.”
In fixed income markets, attention will turn towards the possible contagion of the Brexit vote to other EU countries, says Kommer van Trigt, portfolio manager of the Robeco Global Total Return Bond Fund and head of Global Fixed Income Macro.
“Markets are reacting fiercely to the UK’s vote to leave the EU: government bond yields have dropped, credit spreads are up, and the British pound is experiencing its biggest drop in 30 years,” says Van Trigt. “The main question is what the effect of Brexit will have on the political landscape in Europe. Which country will be next? How will this affect the upcoming elections in Spain?”
‘We do not expect a replay of the 2011/2012 sovereign crisis’
“The European Central Bank and US Federal Reserve will most likely come out with statements and action to support the markets. As the ECB is already active in the market we do not expect a replay of the 2011/2012 sovereign crisis, but it does not circumvent weakness in peripheral markets.”
“The Global Total Return Bond Fund is positioned for flatter yield curves. Developed government bond yields are coming down, and we expect this will have a positive impact on the fund. The fund has a tilt towards the subordinated paper of banks, some of which are from the UK. These positions have been hit, but we do not think that UK banks will have severe funding problems. The fund is not exposed to peripheral sovereign debt, which should help performance overall.”
The stunning Brexit vote stresses the importance of being contrarian in credit markets, say Victor Verberk and Sander Bus, co-heads of the Credit team. “Credit markets are opening very weak this morning after the Brexit vote; the Itraxx Main and Crossover indices opened respectively 30 and 100 basis points wider,” they say. “After a few hours of trading we are slowly seeing buyers emerging in an orderly fashion.”
“We strongly believe it is best to be contrarian in these kind of market events. Selling after this unexpected result is never a good idea. The net asset value of the funds will be lower, but Robeco has fair value procedures to protect our investors. Credit markets still enjoy the strong support by central bank policies, which could be enhanced by further coordinated action.”
‘Volatility can create opportunities caused by irrational behavior by investors’
“The current market environment has an impact on our Investment Grade and High Yield funds. On a total return basis, the funds which will be impacted most are Robeco’s Financial Institutions Bonds, Global Credits, Global and European High Yield funds. The volatility can create opportunities caused by irrational behavior by investors. Robeco’s fund managers are ready to spot any investment anomaly if it arises.”
For equities, it will become more important to pick the future winners as markets sink on the Brexit news, says Mark Glazener, portfolio manager of the flagship Robeco NV equities fund.
“The Brexit comes to a world economy that is already in a low growth modus; the events in foreign exchange rates will not be helpful in this respect,” Glazener says. “A higher US dollar will dampen growth in the US, while a higher Japanese yen will dampen growth in Japan. Uncertainty in Europe and the UK will lead to lower growth in these areas. In Europe the markets could start to reflect the chances of other countries leaving the EU or even the euro. The events will also lead to lower earnings growth worldwide.”
‘We do not see this as a buying opportunity for equities’
“As a consequence we do not see this as a buying opportunity for equities. In the portfolio we have a full position in the US and Canada which will relatively be less effected. We have sold a future position in the UK to neutralize the country risk. In the UK we have no local banks or real estate. The stocks that we do own in the UK have a large part of their sales outside the country, so there the depreciation of the British pound should help. We also have positions in continental European financials like ING and Intesa which could be affected by more than average in terms of equity prices.”
“As always, market dislocations like this bring nervousness to participants and thus opportunities, mostly in individual stocks. We will scan the universe for these kind of opportunities.”