The UK’s vote to the leave the European Union will likely to result in a prolonged period of political and economic uncertainty, and this will present a significant risk to global equities in the context of already weak economic growth and above-average valuation multiples.
So says Ben Laidler, Daniel Grosvenor and Yevgeniy Shelkovsky, members of HSBC’s global equities team, who have cut their year-end global index target by 7% as a result of the Brexit vote, implying a further 5% downside risk ahead.
“This reflects our view that heightened macro uncertainty will increase risk premia and put downward pressure on current full valuations,” said the trio in a research note released over the weekend.
“Our global asset allocation team is cautious equities, recently reducing exposure to only 10%.”
By region, Laidler, Grosvenor and Shelkovsky believe that the largest downside risk to stocks comes from Europe given the UK vote creates “huge uncertainty on both the growth outlook and the sustainability of the whole EU project”.
“This will likely lead investors to attach a higher risk premium to the region’s equities and could also erode the European earnings outlook, which had been one of the key relative positives for the region,” they say.
“Our European strategists do not rule out a return to eurozone crisis valuation levels, which would imply a fall of 30%.”
Yes, that’s 30% additional downside risk. Now that would be a problem for investors and policymakers alike.
“To get there though we would probably need to see the economic numbers deteriorate sharply and the European economy fall into another recession,” they say.
Outside of Europe, and in response to the Brexit outcome coming to fruition, the bank has raised its allocation to US and emerging market stocks to overweight while maintaining an underweight rating towards Japan.
We adopt a more defensive regional allocation, raising the US to overweight (from underweight). We believe the US will relatively benefit from its perceived safer-haven status. Its low beta and relatively closed stock market balance concerns on stretched valuations and peak earnings.
We remain underweight Japan. Our new USD-JPY forecast of 95 for year-end implies further pressure on vulnerable Japanese earnings.
Emerging markets are likely to suffer near term given their high-beta nature, as well as USD and commodity exposures, but it is the one region where valuations remain inexpensive, margins at historic lows, and sentiment extremely depressed. We see more limited downside and remain overweight.
Here are HSBC’s current regional allocations. While the bank is overweight US and emerging markets, it is still forecasting declines in these markets before the year is out.
The less-bad investment option in the current environment, in other words.