As many people no doubt have thoughts on the implication of the Brexit fall out, we are taking notice of the perspective of one of our subscribers on this hot and trending topic. Presented as notes, here are some of this (anonymous) user’s takes on several aspects of what must be considered in the face of Brexit.
Action: Fundamentals unchanged — perhaps a buying opportunity
While financial assets will be beaten down, especially in this irregular 0-rate, confidence-based, speculative environment, fundamentals are likely unaffected; unless, of course, reflexivity breaks down fundamental values — unlikely if we assume there has been, and will continue to be, a disconnect between financial assets and fundamentals. While certain sectors and companies may see FX impact, the “real economy” impacts likely muted, just as real economy impacts have been muted despite central bank efforts. High conviction names should be bought, and longer-term compounders could be at attractive levels in coming days and weeks.
Immediate: Possibly violent overreaction to Brexit
Given the complacency and implied pricing from the betting markets, the reaction to a non-consensus, binary outcome could be violent. Unclear the fundamental impact of a UK exit; sentiment, credit, and currency likely bigger issues. Keep in mind that the UK will need to take months to negotiate a proper exit with the EU.
Temporary shutdown of financing due to Brexit
As the ramifications of Brexit winds its way through markets, extension of capital will likely be on hold. Classic symptoms of this: LBO financing may return to the frozen state seen through 2015, IPO markets may continue to be sluggish for some time, merger arb and inversion spreads widen, etc.
What’s next: reassessment of probabilities, risk of contagion
Previously low probabilities will likely be shifted upwards. More concerning outcome would be contagion (e.g. Netherland’s Wilder already saying it’s “time for a Dutch referendum.”), or a reigniting of anti-EU sentiment. Confidence in the EU since the GFC has already been stretched — can Germany continue to carry the load? Given the current state of discourse, also safe to be pessimistic on the smooth transition for the UK.
Inability of central banks to respond to Brexit
Despite central bank posturing, it’s unclear that there is an orchestrated response plan for Brexit — and much less so for the global economy more broadly. Indeed, it’s unclear that there’s anything central banks can do at this point given limited dry powder and increasingly ineffective liquidity injections; additionally, as investors flock to already low-yielding (including negative yields, this evening now including the 10Y JGB), lower-risk assets, unclear through what channel liquidity will flow through. How much more can confidence in central banks/politicians be tested?
Bigger picture capital flows: shift to sidelines, vs. retreat from speculative assets
Assuming we have seen stretching into increasingly speculative assets (which seems to be true), capital flows likely retreat into “safe havens” in a big way, or directly move into cash — at least, that capital that wasn’t already moved to sidelines in recent weeks. Second derivative impacts — e.g. additional hedge fund impact, reflexive marketing down of asset prices, etc. — may generate losses along risk curve and additional flight of capital. This likely creates buying opportunities. Will be interesting to watch asset prices to potentially expose pockets of speculation.
Broader social concerns
That Brexit was even polling close to 50/50 reflects troubling trends in misinformation, polarization, traction of fringe movements, and xenophobia. These trends are not limited to the UK — the betting markets could be wrong on Trump Presidency as well.
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