Brexit – Did Markets Overreact

SUMMARY

Brexit was unexpected but market reaction is as it should be.

Longer term risk: It may trigger other ‘copycat exits’.

A stronger USD from Brexit.

Did Markets Overreact?

It was against our expectations that the British would have voted for Brexit. The corresponding market reaction is well deserved. Slower economic growth and the need for cheaper and expanded monetary base translated to a weaker GBP. Heightened uncertainty and rush to safe havens saw strong USD, JPY and rates in general. Lower global growth translated to lower equities.

All in all, markets are behaving as it should given Brexit, which is healthy but not profitable. What we were more worried about was financial contagion as London is a major financial center, but thankfully this did not happen.

The Impact in the Medium Term

Fundamentally it is a negative event. It creates lower growth and increases uncertainty. This is never good for equities. But after resetting to a lower market base, we think the incremental negative effect, if any, will fade. We now have a political vacuum and maximum uncertainty of how Brexit will be carried out. These are before potential coordinated central bank response. Going forward, unless there is a real breakup of the United Kingdom and EU, we don’t see significantly more downside risk from Brexit. And even then, those events will take years to pan out.

From Asia and Malaysia perspective, we are far from the epicenter of the negative events. The negative impact is felt through financial markets unwinding. The fundamental impact is less so. So overall, Brexit is negative and markets have reset for this event. However the impact should fade in the next few days or weeks. However, that does not mean the Malaysian market will take off as a result, as our local economic conditions remain weak, earnings outlook is poor and valuations are not compelling.

Will it be a Downward Trend?

Brexit trend is definitely negative. It could potentially lead to many negative events although that is not our central view. It could lead to further break up of United Kingdom with Scotland and Northern Ireland voting to leave. It could lead to break up of EU with countries like Italy choosing to leave. It signifies the rise of more right wing politics and roll back of globalisation, which is bad for trade. It introduces more deflationary impact to an already slow world economy.

Whether these events will pan out as feared, no one knows. These are longer term risk and markets would be affected if it comes through although we are not taking this pessimistic view. It is definitely worth monitoring.

Affects to Foreign Investment in Malaysia

Brexit created a stronger USD, which is negative for Emerging Market portfolio investing, including Malaysia. But the good thing about the Malaysian market is that a lot of foreigners have already exited, given the huge outflow in 2014 and 2015. Furthermore, the foreign inflow this year has reversed. So foreign participation is low, which means they don’t have much to sell, hence they cannot influence the equity market that much.

Sectors To Look Out For

The prospect of more central bank action is expected. Lower interest rates for longer is rapidly being factored into the market. This is of course good for yield driven stocks like REITs and other dividend stocks. With interest rates already so low and some negative, and the failure of developed world monetary policy, a lot of strategists are calling for a different style of economic stimulus. Fiscal policies need to be stepped up where financial help is transmitted directly into the economy instead of via financial markets. Infrastructure spending and more unconventional fiscal policies are possible. This is ultimately good for hard commodities like steel and aluminum. Malaysian companies have a strong affinity for London properties. The property market there was already softening prior to Brexit. Post Brexit, we have financial firms shifting their staff out, lower investment cycle, EU workers uncertain of their status in UK and heightened volatility of the Pound – all these compounds the already oversupplied market. We would be cautious of those Malaysian companies with exposure there, unless we see a pickup in sales. The auto sector is already soft on the back of tighter hire purchase approval, elevated household debt and cautious consumption. Brexit brings along rising USD and JPYand this is ultimately bad for Malaysian auto players, which are net importers.

Performance of Affin Hwang AM’s Funds Post Brexit

The unexpected UK referendum outcome sparked global risk assets selloff in a brutal fashion. As the UK citizen voted to leave European Union, the large gyrations across financial market unnerved global investors. On that day itself, Japan market tumbled -7.26% while stocks in Europe closed sharply lower by -6.84%. The Asia ex Japan equities fell -1.34% on Friday.

Prior to Brexit event, the Affin Hwang Select series equity funds were holding ample cash and positioned defensively. Such cautious portfolio positioning cushioned the funds from the impact of the ensuing market volatility, as evidenced by the resilient fund performance that ranging from -0.3% to 0.6%. Likewise, the Affin Hwang European Unconstrained Fund fell -2.87% on that day, benefiting from the long and short combined strategy. It outperformed the MSCI Europe Index which slid -6.84%.

While market fear appears to have receded somewhat, most of the equity markets have been recovering from Brexit-induced selloff. Our in-house managed Select series funds recouped much of the losses and poised to perform in tandem with the recent market recovery. Also, the externally managed funds have been able to narrow the losses subsequently. The outperformance against market indices demonstrates the value-added benefits by staying invested with us. To navigate the market challenges ahead, we aim to minimise the downside risk in order to deliver positive returns to our investors in the longer run.

Performance of Affin Hwang Select Series Funds: Brexit Day vs Post Brexit

post-brexit-table

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