Brexit can push global markets into a bear phase

In short term, riskier assets could be under pressure even as safer havens like USD and gold remain in demand

Global financial markets were roiled on Friday as contrary to expectations, Brexit, or Britain’s exit from the European Union (EU), became a reality. While experts suggest the referendum will come into effect after December 31, 2017, the interim period will see heightened volatility across global markets as investors seek refuge in safer havens. The risk-off sentiment could see the markets slip into a bear phase – typically described as a fall of 20 per cent or more from peak levels.

What is more imminent now is Brexit would set a dangerous precedent and could trigger chain reaction from other EU members. Already, there are noises that Netherlands, Denmark and Italy could be next. From a financial market perspective, this outcome has far-reaching implications, as it demonstrates that EU membership can be reversed, analysts say.

Andrew Holland, chief executive officer at Ambit Investment Advisors, explains: “The outcome is a huge negative surprise. No one has been happy with the political situation in Europe, because the monetary policy they have been adopting has not been working. This whole scenario of Brexit will now be played out in other European countries as well. So, if it leads to disintegration of the EU, it will be a huge negative. This has the potential to rattle global financial markets, and push global markets into a bear phase.”

Going ahead, the reaction by financial markets will also be seen as an important gauge of how investors look at the United Kingdom’s (UK) prospects. Until it becomes clear what alternative trade model the UK is heading for, the uncertainty will be a significant drag on market sentiment, especially when the markets did not fully price in a Brexit in the run-up to the referendum. The implications of Brexit will be felt across economies and global currencies. Already, the UK pound is down almost 10 per cent. Such sharp depreciation could push other countries to react at a time when growth is anaemic.

Risk assets (equities, subordinated bank and insurance bonds, and high yield bonds) are likely to sell off, says Michael Strobaek, global chief investment officer at Credit Suisse, while safe-haven assets (core government bonds, the Japanese yen, Swiss franc and gold) will be in high demand.

While some argue that central bankers will be more accommodative and that US Fed will most likely postpone the rate hike by some months, the muted economic (growth) response to huge liquidity measures across the world since 2008 is there for everyone to gauge.

While it is yet to be seen how major countries react to soften the impact of Brexit, for the Indian markets, however, there could be a silver lining. Though Indian markets may continue to face headwinds over the medium-term, analysts expect them to perform better than most emerging and developed markets in the long run.

Monsoon, consumption push from Seventh Pay Commission/OROP pay-out, government spending, improvement in earnings growth, reforms, likely passing of the GST Bill and  benign inflation on the back of a fall in crude oil prices are among the main triggers.

“The Indian economy with an enviable macro environment, lower crude oil prices, stable government pushing through reforms, favourable monsoon forecasts and with a banking sector undergone the overhauling process, has enough buffers to withstand Brexit in the short-term. However, in the event there is a domino effect resulting in instability in the EU region or in the event of a recession, the Indian economy may be vulnerable in the medium-term which seems to be a low probability event,” points out a note from Karvy Research.