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Calm markets ahead of the BREXIT storm

The last week of quarter two seemed to have all the action. Anything that happened prior to the EU Referendum was overshadowed by the shock result and the market reaction in the following days.

Global markets enjoyed a period of relatively low volatility over the majority of the second quarter. Accommodative central bank stances and positive macroeconomic releases from both Europe and the US helped to create a positive market sentiment from investors, particularly in risky asset classes such as global equity.

However, at the start of June caution entered the market as the EU referendum approached. The vote to leave the EU sparked a quick drop in the value of Sterling, and indeed the Euro, against the US Dollar. Across the globe markets reacted with a quick sell-off of risky assets and a move to ‘safe-havens’, this prompted a further decline in government-bond yields. By the end of the quarter risky assets had started to bounce back as investors frantically recalculated in anticipation of actions from central banks across the globe.

The quest for yield and high quality assets were the dominating investment themes of the second quarter of the year. The high valuation of equity and government bond markets pushed investors around the world to look for alternative drivers of performance in their portfolios.

Equity markets

Prior to the vote for BREXIT stock markets experienced a period of relative calmness in the second three months of the year. However, shocked by the result, equity markets tumbled on 24 June but quickly regained any lost ground before the end of the quarter.

The top performer in the equity space in quarter two was emerging market equities, despite political and social headwinds in some Latin American economies. In developed markets, the UK’s FTSE100 outperformed other major indices, in part due to weak Sterling benefitting those listed companies with a focus on exports. European and Japanese markets were still underperforming. In particular, banking stocks across Europe were significantly damaged by the vote to leave in the last week of quarter two. The US equity markets were broadly flat in the second quarter.

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Rates markets

This was the best performing asset class for the second quarter running in 2016. Due to the rising volatility in risky assets towards the end of quarter and investor’s continuous search for long-term yield, we have seen large demand for long-dated government bonds which has pushed up prices in the second quarter. Low interest rate policies from central banks have put further downward pressure on yields. The yield of some core government bonds (such as German Bund, UK Gilts) are currently at an all-time low.

Credit markets

Spreads for Investment Grade and High Yield tightened in April and early May. This was in line with equity performance as investors favoured risky assets. Credit assets, particularly in Europe, were further supported by its inclusion in the European Central Bank’s upcoming asset purchase programme. The search for yield continues to push up the valuation of high yield bonds.

Currency markets

The Yen continued to strengthen over the second quarter following a strong start to 2016. This was backed by a strong global demand for safe assets. However, the movement of Sterling has arguably attracted most of the attention over the last three months. The currency’s volatility reached an all time high amid BREXIT risk, and the subsequent vote to leave has driven Sterling to collapse to a 30-year low against the US dollar. Emerging market currencies have further recovered against the US Dollar as the Federal Reserve interest rate hikes have been put on hold for now.

Commodity markets

There has been little progress in a supply side constraint by the Organisation of Petroleum Exporting (OPEC). Despite this the oil price volatility stabilised and oil prices have recovered to go above $50/barrel. This price level has been relatively stable over the past few weeks. The price of gold also continued to have a solid year-to-date performance, this was amid a strong demand from global investors for safe assets.

The second quarter of 2016 was overshadowed by the risk and uncertainties around BREXIT, market volatility rose sharply towards the end of the quarter. Continued geo-political uncertainties and economic weakness may prompt further pickups in volatility in the third quarter.

With high levels of market volatility and political uncertainties around the world investors need to ensure they prioritise capital preservation and long-term real returns. Diversification will be absolutely key to this and investors need to ensure they have liquidity in portfolios so they can act upon market changes.

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