Central Banks Should Guide Markets Through Uncertainty

It will be months before we have answers to the major domestic political questions prompted last week regarding Brexit, the euro and even another Scottish referendum

Neptune 28 June, 2016 | 4:12PM
Facebook Twitter LinkedIn

Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, James Dowey, Chief Economist and CIO at Neptune Investment Management, discusses what to expect in the aftermath of the Brexit vote.

In these very early stages following the “Leave” win any prognosis is by its nature highly tentative. It will be weeks before we are able to measure the acute impact of the result on the UK economy, and there are clearly no close historical parallels on which to base reliable predictions.

Central banks are today much better at calming financial distress than they were a decade ago

Moreover, it will be months – in some cases years – before we have answers to the major domestic political questions prompted last week: who will lead the country following David Cameron’s resignation, will the transition of power necessitate a general election, what will Britain’s economic relationship with the EU look like once the exit is complete, what will it look like in the interim, might the thumping “Remain” win in Scotland trigger a Scottish exit from the UK?

Furthermore, global financial markets during the coming weeks and months may prove to be influenced more by knock-on effects of “Brexit” within the rest of the EU than by news from Britain. Will Brexit trigger a contagion effect within the EU, might the viability of the Euro once again be called into question?

Financial markets abhor such imponderables. So although the tumultuous market conditions that prevailed early Friday morning have dampened down very considerably, we should expect news related to the questions above to create further volatility in asset prices over the coming days, weeks and months.

Investors Should Have Faith in Central Banks

In the face of these new, and in some cases “old new”, challenges to the investment outlook, we believe investors should retain significant confidence in the mitigating effect of the policy response of central banks, even in the context of their somewhat frustrated attempts to generate accelerating growth and inflation in parts of the developed world during recent years.

The key distinction here is the strong capability of today’s central banks to calm conditions of financial distress, putting a floor under economic activity, as opposed to their relatively weak capability to boost a sluggish economy. Moreover, central banks are today much better at calming financial distress than they were even a decade ago. They have certainly had a lot of practice in the interim. This has enabled them to develop effective tools, to “learn by doing” and to build the confidence to act quickly.

This was evident in the Governor of the Bank of England, Mark Carney’s public statement this morning, in which he set out the contingency planning that the Bank has prepared over the past few months and articulated the willingness of the Bank to do whatever is necessary to stabilise the financial system. The US Federal Reserve, European Central Bank and Bank of Japan have all also released statements of willingness and the availability of tools to stem financial distress.

Good Companies Will Continue to Thrive

To be sure, the problems to be addressed following the referendum result are political ones, and will require political processes that are likely to prove to be drawn out, less than efficient and to retain unpredictable elements for a long time to come. But investors should remember that the extent to which such political stress affects the fundamentals of companies is limited by circuit breakers such as those central banks have committed to applying.

Moreover, good companies adapt to the changing “rules of the game” set by the political process and can take opportunities to thrive. We will be monitoring very closely both the risks and opportunities arising from this extraordinary day in British history.

Disclaimer
The views contained herein are those of the author(s) and not necessarily those of Morningstar. If you are interested in Morningstar featuring your content on our website, please email submissions to UKEditorial@morningstar.com

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Neptune  is an independent and privately owned investment management company, founded in 2002 by Robin Geffen.