* Shock Result. Where is the Floor?
Given the recent Remain-leaning polls and subsequent risk rally, the UK’s vote to leave is a nasty
shock for markets this morning. We see potential for 10-15% downside to European Equities over
the next few days as a higher risk premium drives multiple compression. We would discourage
selling should markets fall materially beyond this.
* But…not a systemic crisis at this point
Financial markets will likely react in an aggressive manner this morning and the world has
changed, but from a market perspective this is not a systemic Lehman moment. It is politics where
the main uncertainty now lies, with central bank response also important.
* Uncertainty and Political Risk cloud the outlook
For those tempted to buy UK or European assets once such a floor is reached, the fundamentals
remain tricky. There are a wealth of unanswered questions, with few quick answers. How (or even
if) the UK will exit the EU, and how the spillover to Continental politics plays out are key for the
pricing of risk and the development of earnings.
* Recession, QE, political upheaval
This non-binding referendum vote needs ratifying by the UK parliament to come into effect. There
are possible scenarios where this never happens, but assuming it does the exit path looks lengthy
and murky. A UK recession looks a fair bet. The chance of upheaval in the governing Conservative
party is a further complication. On the Continent, global risk aversion centred on Europe is a
double-blow for Eurozone equities. It will take time for more clarity to emerge, and the BoE/ECB
may act in the meantime. US Equities look (again) like a safe haven.
* How to position for the new world
While UK cyclicals and European financials are obvious candidates for initial pain, risk aversion
and USD strength is also problematic for commodity and EM-plays. On the (relative) long side,
European QE beneficiaries and defensive USD-earners should outperform. We outline sector
implications and stock preferences within the Appendix.