Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Edward Bonham Carter, vice chairman of Jupiter Fund Management looks at how a UK exit from the EU will affect investors
So the British people have spoken and have sent a clear message that they want the future of the United Kingdom to be outside of the EU.
We are now in unchartered waters. In the EU’s short history, no country has ever chosen to leave and our politicians – the vast majority of whom were overwhelmingly in the ‘Remain’ camp – will need to work out how we actually extricate ourselves from the tangled web of agreements and legislation that has been woven around us over the past 40 years.
In the immediate term, the drama at a political level will far outweigh economic impact of this unprecedented decision by the British electorate, in my view. The acrimonious campaign we have witnessed over the past few months has exposed serious rifts in the Tory ranks and the job of negotiating an orderly Brexit may just be the final tipping point that creates unsurmountable divisions in the party. This uncertain political climate is likely to dominate proceedings for some time.
Volatile Markets Ahead
Certainly from an investment perspective, it will be weeks or months before the full implications start to be understood and during this period we will need to be prepared for the potential for a greater level of volatility in financial markets than we have seen since the end of the financial crisis of 2008-2009.
What does this mean for investors? Markets have already moved sharply ahead of the vote so the near term prospects for markets will depend on whether those who wanted to sell did so before the event and whether those who haven’t sold can hold their nerve against some challenging news flow. It is at times like these that a look back into history can provide a guide. Time and again throughout history markets have faced shocks that can seem calamitous. But they do recover. Companies continue to trade, profits continue to be made and stock markets over the long term tend to go up.
The question everyone will want the answer to but is impossible to predict is when the volatility will end and markets will bounce back. In fact history shows that for long term investors, looking through these short term events is beneficial.
Lessons From History: How Long Before Markets Recover?
The FTSE100 suffered its greatest ever drop in a single day on 20 October 1987, the day after Black Monday when the index fell 12.22%, beating the previous day’s fall of 10.84%. It then recovered but took 2.5 years to reach its previous highs.
The impact of the financial crisis in 2008-2009 was different in that markets fell sharply a number of times in reaction to major economic events or fears over bailouts and recession, with several daily declines of between 5% and 10%. The market eventually bottomed on 3rd March 2009 although the crisis itself took longer to end and the FTSE100 took 5.5 years to reach its pre-crisis high.*
Another good example is from the Second World War when the US Dow Jones Index fell in the two years before the start of war, was then volatile for a period before rallying from 1942 until the war ended.
And it is these latter two experiences that I think our exit from the EU will shadow most closely. The magnitude of the declines may or may not be so great but an extended period of uncertainty will lead to greater volatility over a longer period than we are used to seeing as investors react to rumour and speculation before settling into some new version of normality, probably sometime before an exit is actually completed.
The Benefits Of Regular Saving
It also worth highlighting that it is not just the UK stock market that will be affected but other European bourses too. Our exit could raise the spectre of further exits or the breakdown of the entire union and the UK could start to look like more of a safe haven as at least our decision has been made.
For long term investors making decisions in a prolonged period of uncertainty and volatility can be challenging. Trying to time one’s re-entry into such choppy waters can be very difficult and those investors standing nervously on the sidelines may choose to minimise the risk of major misjudgements by investing incrementally through regular savings schemes. These plans buy fewer units or shares in mutual funds when prices are high and more when they are low, helping to smooth out the peaks and troughs of equity markets. At the same time, any market falls in the early years of such schemes often prove beneficial, as those making initial investments can pick up units or shares at more attractive rates than during a bull market.
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