Following the the political fallout following the referendum and the recent action by the Bank of England, MWM are pleased to bring you our latest market commentary covering Q2 2016 (quarter ending 30/06/2016).

In this instalment we look at the impact of:

Brexit
Investor safe havens
An update on Greece
The stabilisation of oil
Emerging markets updates.

If you would like to discuss this market update in more detail, please do not hesitate to contact your usual MWM Financial Planner.

MWM market commentary: setting the scene

Markets staged a volatile display over the second quarter as they tried to interpret announcements from central banks. Geo-political events including the Brexit vote also provided a volatile platform which unnerved many investors. This uncertainty exacerbated fears over the prospects for global growth, even with commodity prices stabilising and the European Central Bank reiterating its commitment to supporting growth.

Focus later shifted to the US Federal Reserve and the debate surrounding the possibility of raising interest rates, as their domestic economy improved. The central bank whilst demonstrating their desire to hike rates, have on a number of occasions explicitly commented about external challenges and their concerns about the health of the global economy and thus any further rises are expected to be very gradual.

One thing of particular note this quarter was the stronger performance by emerging market equities. There have been a number of catalysts for this improved performance including the weakening of the US dollar, stronger commodity prices, and further policy stimulus by some emerging market central banks, together with hopes for positive political change in countries such as Brazil.

Brexit: The day everything changed (or did it?)

Of course the most influential event over the quarter was the surprise outcome of the EU referendum. I feel safe in describing the outcome as a surprise given the evident shock amongst the “Pro-Leave” campaigners the morning after and of course the clear absence of planning. Certainly markets were primed for a ‘remain’ vote, rising in anticipation in the week running up to the vote. When this failed to materialise, the initial shock was felt throughout global markets. Global stocks tumbled, UK Property Companies were hammered and of course sterling plummeted (as predicted), as investors fled to the traditional safe havens of UK gilts, German bunds, US treasuries and gold.

Consequently, the political situation appears challenged to say the least. The prompt resignation of David Cameron following the referendum created a power vacuum within the Conservative Party and with it of course the usual uncertainty that comes with any leadership election. Although Mr Cameron was the immediate casualty of the referendum, he was far from the only casualty. Jeremy Corbyn faced a stuttering but (even now) on-going challenge to his leadership of the Labour party. Several potential leaders of the conservative party saw their hopes of the top job dashed by political infighting in the aftermath that followed the referendum.

Although the referendum result was clear, the legal process for deciding to leave the EU appears less so. It is ultimately Parliament who must make the decision to leave the EU. Whilst it seems unlikely that parliament would choose to directly reject the outcome of a democratic vote, they might seek an alternative route such as a second referendum with a question directly related to whatever deal is ultimately negotiated.

Furthermore, Mr Cameron no doubt added to the uncertainty by making it clear during his resignation speech that any decision to exercise Article 50 would be left to his successor. Article 50 is a hitherto little know clause from the Treaty of Lisbon that provides a framework for a country that wishes leave the European Union. The article provides a two year timeline for exit negotiations but stipulates that negotiations will not commence until such time that the article has been invoked.
In any case, the UK and the EU now face lengthy and complex negotiations to unwind Britain’s 43-year membership of the trading bloc. Given the extent to which UK legislation is intertwined with the EU, the task of detangling presents a significant challenge. New trade treaties will need to be negotiated directly with many countries to replace the existing (EU) treaties. With this comes some rather pragmatic issues, not the least of which being, finding and hiring sufficient number of trade negotiators.

There can be little doubt that “politics” will have an important impact on exit negotiations as EU leaders will be eager to ensure that UK is not seen to benefit from “Brexit.” The fear is that the entire European project could be jeopardised if other EU members hold referendums in expectation of receiving access to free market without meeting the associated requirements such as freedom of movement. There are in any case a number of European elections this year and the fear of a domino effect is already starting to build.

It also opens the question regarding the funding position of the UK, with its twin current account and fiscal deficit. Business investment and consumer spending will likely be disrupted and growth figures will almost certainly trend lower towards the end of the year. Mark Carney, Governor of the Bank of England has commented on supportive measures to contain the economic consequences from leaving Europe. An interest rate cut is clearly one option but the benefits are thought to be limited. Further stimulus in the form of quantitative easing is more likely, which would help stimulate the economy in the short run.

On a more positive note, there is at least increased certainty in the near term with regard to the direction of interest rates. Given the increased volatility and uncertainty, most major central banks, including the US Federal Reserve, seem less likely to hike interest rates any time soon. Ultimately we remain connected to Europe and trade will continue. Our currency has fallen and this at least has the dual benefit of making our exports more competitive and increasing the return (in sterling terms) from our overseas investments. For now markets need to settle and political cohesion needs to be restored.

The hunt for safety

A consequence of investors moving to safe haven assets has been the addition of $1tn to the pile of negative-yielding government bonds over the last month alone. The collapse in bond yields worldwide has followed an escalation of stimulus policies from the Bank of Japan and the European Central Bank this year. Designed to combat low inflation and tepid economic growth, the measures have helped to push the yield on more than $12tn of sovereign bonds into negative territory. At the same time simmering anxiety over the outlook for the global economy is driving investors into the safest and most liquid sovereign bond markets despite the vanishing returns they offer. The question is for how long investors can continue investing in assets delivering such low yields.

Greece ignites again

Greece struck a debt deal that allowed them to unlock €10.3 billion in bailout money from Europe, avoiding another crisis. The event injected some short term comfort within European markets which are already faced with the uncertainty surrounding Brexit.

Creditors had been wrangling over the terms of debt relief allowed to Greece, delaying any solution and creating uncertainty. The €10.3 billion (£7.8 billion) payment is the long-delayed second installment of the bailout deal agreed last August.

Oil stabilises

Oil prices advanced closer to the $50 per barrel mark for the first time since last November, on growing supply disruptions across a number of countries including Nigeria and Canada. While a more positive assessment of the market from Goldman Sachs, citing strong demand from India also helped firm the price. The price of oil has become a barometer gauge for the health of the global economy and with the price stabilising to a degree, it has provided some well needed relief to the current political uncertainties driving markets.

Emerging markets

Chinese headlines dissipated somewhat over the quarter with the build up to the European referendum. However, authorities did announce it would pump Rmb4.7tn ($721.8bn) into transportation infrastructure over the next three years, supporting 303 projects across the country, including railways, roads, waterways, airports and metro systems. The move is likely to boost many industries as Beijing struggles to reduce gluts in many industries and reverse an export decline that threatens further job losses.

After a lengthy impeachment process, the Brazilian Senate finally suspended President Dilma Rousseff for allegedly using State funds to cover budget shortfalls. The vote in the Brazilian Senate will not eradicate the political uncertainty that has prevailed during the process as Brazil still faces significant structural challenges. With the path of Brazil’s future far from certain, it has offered some light relief to markets with the prospect of a more market friendly leadership ahead.

Conclusion

Looking ahead, investors will remain focused on the actions and rhetoric of the US Federal Reserve. With labour markets continuing to strengthen, the Dollar is no longer appreciating strongly, and energy prices apparently having bottomed out, inflation could move higher in the medium term. However, Fed chair Janet Yellen’s determination to proceed cautiously before lifting rates appears more believable given the recent UK result and the implications on growth that this brings.

Overall business confidence remains lacklustre as concerns about the global economy continue to be exacerbated by uncertainties at home, particularly with nerves unsettled by issues such as Brexit and the prospect of further government spending cuts announced in the Budget.

Ultimately markets will continue to be driven by politics and monetary policy as we have seen abundantly in the last few years. We will remain in this low growth world with a continuation of policies by central banks to drive markets ahead. Geo-political events remain a threat but also provide opportunities. As is so often the case with the closing statement of our Market Commentary, “portfolio diversification” will remain a very important tool in this rapidly changing environment.

Although policy measures taken by the central banks around the world have made global recession a less likely scenario in the near term, one should question whether monetary easing alone, without corporate earnings, is sufficient to sustain market momentum.

About Menzies Wealth Management

Menzies Wealth Management is a subsidiary company of the Menzies Group, providing independent financial advice to both private and corporate clients. We are independent of all financial institutions.

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Disclaimer
This document (market commentary) is intended for general information purposes only and does not constitute advice. It is based on our current understanding of legislation, which may be subject to change. Menzies Wealth Management can accept no responsibility for any loss resulting from acting or refraining to act as a result of any material in this publication. Past performance is not a guide to future performance and the value of investments may fall as well as rise. Personal taxation will depend on individual circumstances. The Financial Conduct Authority does not regulate taxation and trust advice, or some types of mortgage.

Menzies Wealth Management is authorised and regulated by the Financial Conduct Authority 486548

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