JP Morgan’s Flanders outlines economic and investment expectations
Stephanie Flanders, chief market strategist for Europe and UK, JP Morgan Asset Management, summarises expectations around the impact of Brexit on UK and other economies and the overall implications for investors
The EU referendum result is a political earthquake for the UK, with important economic consequences that will hang over the country for years, if not decades. But the impact for other countries and markets will depend on how close they are to the epicenter.
UK economic and political uncertainty is now certainly elevated. This heightened uncertainty alone is likely to have a substantial negative domestic economic effect as some hiring decisions are likely to be stalled and investment in the UK is likely to fall.
We expect Brexit-related uncertainty to take at least one percentage point from UK growth over the next year, and the fall in the pound could add around one to two percentage points to inflation. But the immediate hit to eurozone spending and growth ought to be manageable.
Bad for the economy
Brexit may be viewed as bad for the economy, but it is important to remember that the UK stock market is not a very good reflection of the UK economy. Over 70% of FTSE100 revenues come from abroad.
It is expected that the UK economy will be hit more than others, and that sterling could still fall further.
This would tend to favour companies which generate most of their revenues abroad, and suggests a preference for large cap equities over the more domestically exposed mid and small cap companies.
UK listed tobacco, healthcare, energy and personal goods companies all have small exposures to the UK economy and have attractive dividend yields in a now even lower yield environment for bonds.
Broader political impact
It is difficult to calculate the broader political impact of Brexit. Europe still needs reforms to create conditions for healthier economies with faster growth and less debt burden in the coming years. If Brexit hastens the rise of these anti-mainstream parties, then that could make these reforms even harder to achieve.
Although the outcome of the vote promises to deliver a period of uncertainty and volatility, European equities could benefit from a supportive European macroeconomic environment.
While earnings aren’t particularly exciting, for many global investors now looking for income, there is an important attraction of a nearly 3.5% dividend yield on the Euro Stoxx, compared to negative yields on 10-year German government bonds.
But there is more to the life than Brexit – at least for financial markets.
The global economy can and should continue slowly to recover and US rates can eventually start to move up again. But for that to happen, the broader economic and political fallout from Brexit has to be containable, particularly in Europe and US productivity and corporate earnings need to start to recover.
These two developments, along with a broadly stable dollar, would boost confidence in the recovery and help support markets as we move towards 2017. But central banks have limited room to respond if events do not follow the script.
There is no shame in having few high convictions in this environment. It makes sense for investors to seek more balanced portfolios and lower their expectations for future returns.
Now more than ever, investors will need to take a global view.
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