Investment strategy: "Risk has risen, but not to a systemic level"

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ABN AMRO Private Banking

From a vote that had been too close to call and despite a ‘relief rally’ up until yesterday, the British have chosen to leave the European Union in a historic referendum. Initial market reaction has been swift and negative. So far this morning, risky assets have corrected by 5-10% and a flight to safety within bond markets has been seen, evidenced by a significant decline in German Bund and US Treasury yields.

Risk has risen, but not to a systemic level

The Global Investment Committee, at its meeting this morning, recognizes that risk, and, in particular, political risk, has increased. It is not believed, however, that systemic risk for the economy and therefore markets, is on the horizon. A recession in the eurozone or the US is also not expected. 

As detailed in today’s publication from Group Economics, "The consequences of Brexit", the effects on the UK economy will likely be more severe and a downturn is expected there. Already the British pound has fallen by 8% against the euro and 12% against the US dollar from the highs of yesterday, before recovering somewhat.

Stabilisation is expected

Market volatility is rising as part of adapting to the new reality represented by Britain’s exit from the EU. It is still very early to try to predict the path markets will take. Nonetheless, stabilisation is expected. This is owing to the elements of damage control and risk mitigation that are already apparent.

Moderating forces include the supportive role of central banks  and the UK political system, which will work to ensure an orderly process for the UK’s exit and its future negotiations with the European Union. European diplomacy will also have a key role to play. 

Of course, one of the key concerns is contagion risk, in terms of both the political situation and also in terms of financial markets. More about contagion in financial markets will be known after US markets open this afternoon. And the Spanish elections on Sunday will provide a signal of the mood within Europe. The committee expects, however, that the US equity market will benefit (relatively) from its perception as a safe-haven for stock investors. The US market is also attractive given that the start of the rate-hiking cycle in the US will likely be further delayed because of international concerns. The delay is evidence of the commitment by central banks to take coordinated action, if needed. 

Within equity markets, the financials sector (especially UK banks) is expected to be the hardest hit, while defensive-growth and dividend-yielding stocks continue to be preferred. In fixed income markets, it is an environment of lower yields and rising spreads.

Investment recommendation: wait for stabilisation

Over the past few months, the committee has taken several steps to insulate the portfolio from the risks of a decision by Britain to leave the EU. These steps included reducing equities, creating a cash buffer, neutralising the regional equity allocation between the US and Europe and reducing the peripheral government bond allocation. A core (US, Germany and Japan) government bond active duration strategy was also put in place.

In an environment of increasing uncertainty, the committee recommends waiting for markets to stabilise before re-entering. Volatility across all markets, including 'safe havens' is expected. The period of market adjustment will likely abate in the coming days. The GIC will wait for this stabilisation in volatility to occur before re-entering assets that may represent attractive opportunities over the medium-term.

Didier Duret, Chair Global Investment Committee

Gerben Jorritsma, Head of Investment Strategy & Portfolio Expertise