Surprise Result

The UK referendum on its membership in the European Union has delivered a surprising win for Brexit supporters, by a margin of 52% to 48%. With no clear timetable on what happens next, uncertainty and political upheaval are likely to dominate market sentiment in the coming days and weeks.

 

If equities were to go back to the depths of the European Credit Crisis of 2012, then the downside could be as much as 15–30% (from Thursday, 23 June levels). Some mitigating factors, however, such as interest rate cuts by the Bank of England and European Central Bank, should mean markets can avoid re-testing the lows of the European Credit Crisis.

 

The downside for Australian equities should be milder, assuming contagion to our key trading partner, China, is limited. Following post-Brexit moves, the S&P/ASX 200 Index is now on a 12-month forward price-earnings multiple of 15.3 times, which is still elevated considering poor earnings growth in the corporate sector and the long-term average PE multiple of 14 times. All else being equal, moving back towards a 14–14.5x multiple, where we would see support kick-in, would suggest further downside of around 5–8% from Friday’s level.

 

Overall, we think the outcome remains supportive of keeping portfolios largely defensive, with a preference for yield-based strategies (a theme we highlighted recently as bond yields fell and yield gaps widened) and a tilt towards beneficiaries of a weaker Australian dollar. We expect the bargain hunting to centre around these areas.

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