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Newsletter, Q4 2016
Sharpe thinking Brexit, the case for Asian cyclicals and the technology that exposed Volkswagen
Key points The impact of monetary policy has weakened substantially, a trend thrown into sharp relief since Brexit Emerging market currencies are recovering and the outlook for their economies has strengthened this year
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Horiba, the Japanese manufacturer of the testing equipment that revealed Volkswagen’s emissions cheating, is a promising opportunity in the small cap universe We also provide views on the US, Europe and Asia ex Japan stock markets
Newsletter, Q4 2016
Brexit and the policy response: what markets want, markets get Andrew Parry Head of Equities The vote for Brexit dominated newsflow over the summer, impacted markets and led to a new UK prime minister. But in this world of weak growth, extremely low bond yields and coercive central bank policies, where the most reasonable market prediction is that frequent spikes in hope and fear will continue, Brexit is just one of many forces contributing to ongoing volatility. The dire predictions about the fate of global markets if the UK voted to leave the European Union (EU) failed to be fulfilled. Markets fell in the immediate aftermath of the vote for Brexit, especially sterling, but the anticipated collapse of equities failed to materialise. The pan-European indices have declined by less than 1% in euro terms, and, even at their worst, none of the major markets sank below their February lows. In fact, the S&P 500 reached a new all-time high in late August. Even UK mid-caps are up 3.4% from their pre-referendum level, and well off their post Brexit lows, despite being in the direct path of a widely predicted, but still absent, UK recession. An even more startling metric is that since the close of business on 23 June, when Britons cast their votes, the MSCI World Index has risen by 15% in sterling terms – very near an all-time high. Armageddon appears to have been postponed.
Since the close of business on 23 June, when Britons cast their votes, the MSCI World Index has risen by 15% in sterling terms – very near an all-time high. Part of the reason for the relatively benign outcome is that most investors were already positioned bearishly. High cash levels, reduced equities exposure and large open put options provided strong technical support. Such pessimism was not based on politics alone – the consensus view was that the UK would vote to remain in the EU – but fears of stagnating global growth. Monetary authorities, which have learned from previous crises, indicated that they would take action to support markets, and the Bank of England duly delivered. The need for investors to earn a profit also contributed: with $13tn of government bonds globally providing negative yields, the hunt for attractive returns continued.
Liquidity gluttons What happens now? Markets expect that central banks will continue to stimulate growth and support asset prices. This is a typical Pavlovian response in which markets habitually associate uncertainty with stimulus, and exhibits their faith in the benefits of central bank intervention. The Federal Reserve’s glacial approach to raising interest rates, combined with upbeat US jobs reports, plus the reintroduction of QE by the Bank of England, and expectations of further stimulus in Japan, encourage investors’ sanguine view of the world.
But central banks, as influential as they are, cannot alone dictate the course of the global economy. The full consequences of the ‘leave’ vote are unknown and were never going to be felt in the short term: the ramifications will unfold over the rest of the decade and blend in with the ebb and flow of the global economy. What we do know is that there is unlikely to be any immediate surge in growth, ev