Brexit risk spurs little change in our strategies

Genevieve Signoret

Letter from Queretaro

According to polls, the risk that United Kingdom voters will choose to leave the European Union is about 50%. If voters choose to leave the EU, the likely outcome in our view is that all risk assets will sell off for 1–3 months and that, during this time, safe-haven asset classes will spike.

Safest of all havens are U.S. and Japanese government bonds, the longer-term the better. The problem is, Britain’s voters could choose to remain in the EU, producing opposite market results. Thus, any over-concentration in safe-haven asset classes could backfire. Furthermore, we judge that, even in the event of a Brexit, the drop in risk asset valuations will be short-lived—say, three months long.

Our argument is one by now familiar to our readers: investors are chronically thirsty for yield, and global rates are hovering near zero. Any bout of market panic will tighten market conditions, rendering the need for a Fed rate hike in the next few months moot. Also, the euro area and Japan are likely to expand monetary stimulus no matter what. Hence, cash and even bonds will pay hardly any yield, so increased appetite for cash positions will be short-lived. Eventually, two things will happen. First, they will realize that, although a Brexit is a global macro negative, it poses virtually no short-term risk to the global financial system—it’s no cause for panic. Second, investors will no longer be able to contain their thirst for yield.

Given these views, for clients whose investment horizons exceed six months, we are making no changes to portfolio strategies except to protect funds needed in the next six months by putting them into dollar cash or short-term (1-3-year) U.S. Treasury securities.

Remember, except for clients whose investment horizons stretch beyond a decade, all our clients are currently holding 20–30% of their portfolios in long-term U.S. Treasury securities. These USTs will spike in the event of a Brexit. This “insurance” will serve to moderate to some degree any short-term portfolio losses.

Remember also that, currently, we’re dollar bulls—at least 85% of all client portfolios, regardless of where they are held, are allocated to assets denominated in the safe-haven U.S. dollars.