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Market Views Brief
Russell T. Price, CFA®, , Senior Economist
Anthony M. Saglimbene, Global Market Strategist
Brian M. Erickson, CFA®, Fixed Income Strategy
June 16, 2016
RISING BREXIT CONCERNS COULD FUEL MARKET TURMOIL OVER THE NEAR-TERM
• Odds of the United Kingdom leaving the European Union (EU) have risen over the last few weeks as recent polls have
unexpectedly shown the “leave” camp with a modest lead.
• Evaluations suggest the U.K. would suffer moderate negative economic implications with an exit. Remaining Union
members could also see some modest negative economic costs as well.
• An exit would not occur immediately. Governing treaties call for a two-year period of re-negotiation. The Financial
Times quoted an unnamed senior U.K. government official as saying Britain would seek to leave the EU by 2019 and
defy current immigration rules immediately if voters choose to exit.
• Most of the economic “costs” would be incurred in trade, finance and direct investment. U.K. borrowing costs in
international markets could also rise.
• Financial companies would likely bear much of the burden from a sector perspective. London is widely considered the
financial center of Europe and many of the city’s largest banks have already revealed specific plans for relocating jobs
and functions to other EU-based locations upon an exit.
• Globally, the direct economic consequences of a Brexit would likely be slight. Economic confidence, however, could
take a hit from any resulting financial market turbulence and the added uncertainty would be a negative development
the world economy does not need given its already weak pace of growth.
• The more meaningful risk could be the message a U.K. exit may imply regarding the long-term cohesiveness of the
European Union itself.
• The U.K. is a member of the 28-nation European Union but not a member of the 19-country Euro Zone.
On June 23, voters in the United Kingdom will take to the polls for a referendum vote regarding the U.K.’s ongoing
membership in the European Union – a vote that is often referred to as: the “Brexit,” shorthand for British exit. In the runup to elections in May 2015, British Prime Minister David Cameron promised that if his party were re-elected, a referendum
vote on the U.K.’s membership in the European Union would take place before the end of 2017. Mr. Cameron’s party won
and on February 20 of this year the date of the referendum vote was set.
Up until about a month ago markets had shown little concern for the Brexit vote. Most participants (including ourselves)
seemed to believe U.K. voters would seek to stay in the Union given widely published reports of the potential economic
consequences. Recent polls, however, have been a wake-up call. A greater number of voters seem to take issue with the
loss of sovereignty Union membership has brought, especially in the areas of immigration and regulation. The U.K. has
experienced a large influx of immigrants over the last several years. Under Union treaties immigrants have free mobility
amongst member nations and the U.K. experienced outsized arrivals given comparatively good employment prospects.
The Brexit vote has become a notable source of uncertainty for financial markets. From a very high level, this added
uncertainly will likely lead global capital flows to perceived areas of safety. This generally means U.S. based assets, which
includes the U.S. dollar, bonds, and to a lesser extent, equities. Precious metals and commodities could also see some
positive investment flows.
© 2016 Ameriprise Financial, Inc. All rights reserved.
FOR IMPORTANT DISCLOSURES, INCLUDING POSSIBLE CONFLICTS OF INTEREST, PLEASE SEE THE LAST PAGE OF THIS DOCUMENT.
Market Views Brief
June 16, 2016
Economic impact: If the vote is to “stay” the economic outlook remains status-quo; eliminating the uncertainty could even
be a modest positive for near-term momentum.
Various independent studies have forecast negative implications for the U.K. economy upon a Brexit. Targeted
consequences largely reside in the areas of trade and finance. This has translated into pressure on European banking and
finance company shares, recently. Some of the world’s largest financial companies with operations in London have already
offered specific post-Brexit plans for moving jobs and functions to other EU locations. Proponents of an exit argue that the
U.K. would benefit from less regulation away from the EU and the country would be able to negotiate beneficial trade deals
with the U.S., China, and other global economies.
Approximately 51 percent of U.K. exports go to other EU member states, according to the International Monetary Fund.
Renegotiated trade deals upon an exit would not be as favorable as they are under EU membership. This would be
intentional as favorable terms would offer encouragement to other nations to possibly consider leaving the Union.
The Organization of Economic Cooperation and Development (OECD), a cooperative of the world’s rich nations, has
estimated that a Brexit could lower total U.K. GDP by 3 percent by 2020 – largely due to lower exports and higher trading
costs. The Center for Economic Performance at the London School of Economics and Political Science, estimates that an
exit would reduce U.K. income by 1.1 percent of GDP under their “optimistic scenario” of future trade negotiations, and by
3.1 percent of GDP (approximately £50 billion, or ~$71 Billion) under their pessimistic scenario. The Bank of England has
stated implicitly that a Brexit would slow U.K. economic growth, foster inflation (due to a weaker British Pound), and boost
unemployment (in May the U.K. unemployment rate ticked down to 5.0 percent). The U.K. is the world’s fifth largest
economy, representing approximately 3.9 percent of global activity, according to International Monetary Fund data. The
European Union is the world’s second largest economic region (behind the U.S.), accounting for 22 percent of total global
activity.
Offsetting some of the potential economic costs, the U.K. government would save the annual remittance it provides to the
European Commission of approximately £20 billion (~$28 billion). “Stay” supporters note that approximately £12 billion of
this comes back to the U.K. in rebates and programs, for a net annual cost of approximately £8 billion.
Financial market impact:
Ahead of the vote: Increased market volatility across global markets over the last few trading days is primarily attributable
to shifting Brexit odds, in our view. As a consequence, global government bonds have rallied, pushing 10-year yields
significantly lower. Additionally, defensive equity sectors such as Utilities and Telecom have significantly outperformed
more cyclical areas of the equity market. Near-term, investors should expect higher levels of volatility heading into the vote
as well as shortly thereafter.
The “safety trade,” i.e. government bonds and defensive sectors are likely to remain in demand as the vote draws near.
However, investors following a well-established asset allocation approach should continue as usual and avoid making
material portfolio changes based on Brexit, in our view.
Post-Vote: If the U.K. votes to remain in the EU, life goes on and markets should respond favorably. The pre-vote flight to
safety would likely unwind and provide an opportunity for pressured areas of the market to recover. We note that
European equities have experienced significantly more selling pressure this month compared to domestic equities and a
modest relief rally could ensue if the Brexit overhang were to disappear. Conversely, defensive equity sectors could
experience some selling pressure as safety trades are unwound.
If U.K. voters decide to leave the EU, then investors should prepare for more volatility. We believe selling pressure would
be focused primarily in Europe and in areas most exposed to the financial sector. Talk of “who’s next” could intensify, as a
weakened EU would not only have to deal with the long road of a breaking-up with the U.K., but maintaining a strong and
cohesive membership.
© 2016 Ameriprise Financial, Inc. All rights reserved.
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Market Views Brief
June 16, 2016
U.S. equities are more insulated from the Brexit vote, but they are not an island. We would expect markets globally to react
negatively to an exit vote, but likely settle over the intermediate-term as the longer-term influences are evaluated.
Markets will figure out the longer-term impacts over time and reward/penalize the appropriate areas of the market. Our
current tactical allocation guidance calls for higher allocations to U.S. equities relative to European equities, with a modest
underweight to Developed International equities as a whole. In light of the Brexit issue—we believe this allocation
continues to make sense.
Bond Market: Lean Toward Quality
A vote for the U.K. to remain part of the European Union likely removes a source of concern for the markets in the nearterm. Ten-year Treasury yields declined 27 basis points to 1.58 percent on June 15, down from 1.84 percent at the end of
May. Meanwhile, 10-year U.K. Gilt yields slid 31 basis points to 1.11 percent and 10-year German Bunds fell 14 basis points
to -0.01 percent over the same timeframe. While we do not anticipate a sharp rise in yields of the more than 25 basis points
from the Brexit move alone, we believe a confluence of factors could lead to a more substantial sell-off akin to the
April/May 2015 rout of 90 basis points off a quantitative easing induced low for Gilts and Bunds.
We believe a vote for the U.K. to exit the European Union may prompt investors to seek safe haven assets including Gilts
and Treasuries in the near-term due to the uncertainty raised around how to untangle the UK’s EU membership. Gilts could
benefit from a more accommodative policy stance from the Bank of England and domestic demand for safety. We
anticipate U.S. Treasuries could be a key benefactor as well given moderate yield levels and the potential for a firming in
the U.S. dollar. Further out, we believe the uncertainty from the potential interest from other Eurozone Members to exit
the union could turn German Bunds into less of a safe haven destination as concerns increase that the EU’s financial
powerhouse could end up bearing a disproportionate financial burden from other EU members that explore an
exit. Certainly ongoing Bund purchases by the central bank could offer a buffer, but more sellers could emerge to challenge
the 10-year Bund’s recent decline into negative yields, in our view.
The Ameriprise Global Asset Allocation Committee lowered our developed foreign bond allocation to zero at the end of the
first quarter, removing a segment that could have been highly impacted by a Brexit vote in our view. In the near-term we
believe our current fixed income positioning likely offers a modest performance contribution from core fixed income
sectors partially offset in the very near-term by our elevated positioning to high yield bonds. Over our 3 to 12 month
forecast horizon, we anticipate U.S. high-yield credit performs well as added monetary policy stimulus leads investors to the
steady U.S. economic growth and larger yields offered by U.S. high yield. As a result, we would recommend investors stay
the course with our current fixed income recommended allocations, whether investing tactically or for the long-term.
Currency market impact: Consistent with our view that an exit (or prospects of such) would entice money to move to
areas of perceived safety… Brexit concerns will likely pressure the British Pound and to a lesser degree the Euro, while
boosting the U.S. dollar and to a lesser extent the Japanese Yen. All else remaining equal, a weaker Pound and Euro could
over time, bring a mild positive economic benefit in making exports cheaper and re-heating the London real estate market.
The net impact would likely remain negative, however.
Summary: Brexit vote concerns are likely to pressure markets over the near-term, fostering some capital to move to ports
of perceived safety. We would expect a subsequent relief trade if the vote is to stay, or conversely some added near-term
downside if the vote is to exit. We do not see the issue as having broad or lasting economic repercussions, however. Nearterm the vote is likely a larger financial market risk than it is an economic one.
A more significant concern over the longer-term could be the message a U.K. exit sends to the world about the long-term
cohesive prospects of the European Union itself. The financial crisis and subsequent European Sovereign Debt Crisis
presented the 28-nation association of countries with considerable challenges; especially for the 19-members of the Union
that are also members of the Euro Zone (they each use the “Euro” as a common currency). The common currency utilized
by this diverse membership has widely been seen as making the region’s recovery from the Great Recession more difficult.
© 2016 Ameriprise Financial, Inc. All rights reserved.
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Market Views Brief
June 16, 2016
IMPORTANT DISCLOSURES
The views expressed in this publication reflect the personal views of the Ameriprise Financial Services, Inc. analyst(s) authoring the publication.
Further, Ameriprise Financial Services, Inc. analyst compensation is neither directly nor indirectly related to the specific recommendations or views
contained in this publication. For important disclosures on securities mentioned in this analysis, please review available third party research reports
and charts with applicable disclosures on our website at ameriprise.com, or through your financial advisor, or by submitting a written request to
Ameriprise Financial Services, Inc., 1441 West Long Lake Rd. Suite 250, Troy, MI, 48098.
International investing involves increased risk and volatility due to political and economic instability, currency fluctuations, and differences in financial
reporting and accounting standards and oversight. Risks are particularly significant in emerging markets.
DISCLAIMER SECTION
Except for the historical information contained herein, certain matters in this report are forward-looking statements or projections that are dependent
upon certain risks and uncertainties, including but not limited to, such factors and considerations as general market volatility, global economic and
geopolitical impacts, fiscal and monetary policy, liquidity, the level of interest rates, and historical sector performance relationships as they relate to
the business and economic cycle.
This summary is based upon financial information and statistical data obtained from sources deemed reliable, but in no way is warranted by
Ameriprise Financial Services, Inc. as to accuracy or completeness. This is not a solicitation by Ameriprise Financial Services, Inc. of any order to buy
or sell securities. This Summary is based exclusively on an analysis of general current market conditions, rather than the suitability of a specific
proposed securities transaction. We will not advise you as to any change in figures or our views.
Past performance is no guarantee of future performance.
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