Britain’s decision to leave the European Union has triggered political upheaval in the UK and surprised investors worldwide, weighing on risk assets and boosting demand for perceived safe havens.
Much remains uncertain as to the consequences of Thursday’s referendum. But even at this early stage, it is clear that the result presents both challenges and opportunities for investors.
The immediate economic impact will probably be felt more in UK, where a constitutional crisis now looms, although the EU and euro-area will also face pressure. As companies delay capital expenditure and investment decisions, growth will probably suffer.
The challenge for EU leaders, first and foremost Angela Merkel, the German chancellor, is to maintain trading relations with the UK at the same time as preventing further referendums in the 28-member union.
More broadly, the vote for so-called ‘Brexit’ is a sign of rising global political risks, with populist politicians advancing against a backdrop of income inequality and stagnant wages. Any moves towards protectionism resulting from this trend would hurt world trade and export-orientated economies.
For emerging markets, the direct economic impact is mostly limited to those companies that trade with UK and Europe; broker research estimating this could shave 0.2% off gross domestic product. That said, the near-term hit to risk appetite, seen in the weakness in global equity markets, is a concern for investors.
The Federal Reserve is likely to delay raising interest rates again for even longer, in a boost to Asian issuers of US dollar-denominated debt – although a stronger dollar, a function of the risk-off environment, would likely put pressure on emerging-market currencies over the year. The Bank of Japan, meanwhile, will probably expedite further stimulus measures to weaken the yen.
Scope for Asian outperformance
We expect markets to remain volatile in the short-term, with further demand for perceived haven assets, as fear and even irrationality prevail while the UK tries to chart a new path and the euro area’s frailties again come under the spotlight. But from a relative-value standpoint, Asian equities in particular could outperform the US market, which looks expensive, and Europe, which is in turmoil.
Asian markets have been out of favour and under-owned for some time. Following the shock of Brexit, it is likely that domestic policy will be supportive in the region – especially in markets we favour like India, Indonesia and Vietnam, where the referendum’s impact should be limited.
The immediate effect on China is likely to be contained, given the relatively small size of the UK as a destination for its exports; certain markets with higher proportions of exports to the UK, such as Cambodia, may suffer at the margin.
As very few of the stocks we hold within our Asian portfolios are impacted by weakness in UK or Europe, we have made no material changes to our views or positioning. Most of our stocks are leveraged more to the Asian economy and are typically domestically focused; infrastructure plays, for example.
Ahead of the referendum, we had been running slightly higher-than-usual cash levels given recent strength in markets, the prospect of UK vote and uncertainty around the renewal of the Indian central bank governor’s tenure.
Now, to capitalise on market dislocations, we have selectively used some of our cash position to buy oversold names – especially where they offer a decent dividend yield. We have also partially closed an underweight to Australia, after that market saw sharp declines despite having little exposure to the UK or EU.
Over the short term, we plan on continuing to purchase stocks that have fallen materially yet lack sensitivity to those countries most affected by Brexit. We intend over the medium term to keep the portfolio tilted towards value and mid-cap stocks that should outperform as earnings expectations in Asia bottom out. And over the long-term, we remain focused on building out and identifying structural growth themes that are uncorrelated to the broader market.