Brexit dominating the market

20-06-16 15:46 | Markets and investments The temperature is undeniably rising ahead of 23 June and markets, at least in Europe, have reacted negatively lately. The media storm around the referendum is thunderous, speculation is in abundance, yet the question remains – Bremain or Brexit? And, how should investors position their portfolios?

Nordea’s Investment Strategist, Michael Livijn comments:

A Brexit from the EU would pose a major potential risk. It’s easy to get caught up in it. The uncertainty triggers the natural reaction of wanting to try to minimise the risks (and hence potential losses) in savings.

To put it plainly, should all risky investments be sold off? Our answer to that is no.

Nordea’s advisory model is based on strategic allocation – that is, what the long-term risk level in a portfolio should be. The risk level in itself is individual, but the basis is the same, irrespective of whether the investor has a low or a high risk appetite. The market will always focus on individual events that could pose a risk. A potential Brexit is just one of several events in the past few years that have caused turbulence.

In other words, new risk situations will emerge, even after 23 June. If one were to react by selling in each potential risk situation, there would be no long-term plan for the savings at all, yet it is the long-term plan that is actually most significant to return over time. An eternal piece of advice is to verify and perhaps adjust the portfolio based on the strategic allocation selected from the beginning. For example, if you have 50% equities and 50% fixed income instruments in your portfolio, make sure that those percentages are maintained. That way, you are at your long-term risk level, which should also cope with periods of turbulence.

Brexit or Bremain?

The opinion polls are neck and neck, although at the same time there is a great deal of uncertainty about their reliability. The factor that has filled the market with dread is the momentum of the Brexit camp in the past few weeks, irrespective of polling method. What happens in either scenario is of course difficult to quantify in figures. One of the key questions is, however, how much the market has already priced in, considering that the Brexit camp has strengthened. Considering how European equities in particular have performed of late, we venture to say that a Brexit is priced in to some extent.

Europe is down around 6% since the turn of the month, and Swedish equities have declined slightly more. Long yields have declined, and the German 10-year yield has entered negative territory – an indication of prevailing risk-off, particularly in Europe.

At the same time, it is a volatile environment so daily fluctuations in both directions are substantial.
In the event of Bremain there will probably be a relief rally, recouping a substantial amount of the downturns. Yields would rebound and spreads (between the borrowing and lending rate) in credits would probably narrow.

In the event of Brexit, it is impossible to say whether equities (primarily European) would decline 3%, 5%, 8% or 12%. In terms of the performance of regions in relation to each other, however, the US and Japan would fare better thanks to their defensive nature. Europe and emerging markets would be among the worst performers.

In the case of British equities, the outcome is slightly less certain. Many FTSE 100 companies are entirely international with around 80% of sales abroad. It is therefore not entirely obvious that they would be major losers, because the GBP would weaken in the event of a Brexit. Long yields would go even lower, and spreads on the credit side would widen. Again, judging the extent of the movements is difficult, not to say impossible.

In strategic terms, we therefore make no changes to the tactical allocation. Since March, we have had a neutral view of both equities and long yields in the tactical allocation, an approach we are comfortable with in the current climate.

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