21 October 2016
Brexit might trigger many unexpected “black swan” events in Europe. Photo: Bloomberg
Brexit might trigger many unexpected “black swan” events in Europe. Photo: Bloomberg

What’s next for Europe after Brexit?

Global equity markets rebounded after two to three days of slump following the Brexit vote.

It’s widely believed that the risk for the United Kingdom, Europe or even the whole world is basically manageable.

The FTSE index is still up 5 percent this year, while the sterling has plunged 12.06 percent against the dollar, or a 7 percent fall if dollar-denominated.

Germany’s DAX has dropped 11.3 percent, although the euro has risen 1.73 percent against the dollar.

The German market has slumped 10 percent in dollar terms, still lagging behind the UK.

Meanwhile, Dow Jones and S&P 500 have posted rallies of over 2 percent, and the healthcare index has risen 3 percent this year.

Asian markets have outperformed. The Philippines, Vietnam, Thailand and Japan’s TOPIX and Mothers Index have all reported double-digit growth year-to-date, while other markets like Taiwan, India and Indonesia have risen 3 percent, 4 percent and 8 percent respectively.

Also, the gold price has soared 28 percent this year, and a number of gold mining stocks have posted multi-fold jumps.

High-dividend stocks and bonds also fared well. The Nasdaq telecom index increased by 3.7 percent, and relevant funds even jumped by 12 to 13 percent, far exceeding the benchmark.

Many emerging market bonds reported double-digit returns.

The Hang Seng Index has trimmed its rally to a single-digit, but I believe it’s very likely to post a 5 to 10 percent rise this year.

The reason is simple. Most blue-chip stocks are very prudent companies, and they have very stable dividend-paying ratios.

Currently, the dividend-paying ratio of the Hang Seng Index is 3.95 percent, better than the negative yield of government bonds and 2 percent in the US markets.

It’s been reported that up to US$11 trillion of bonds now have negative yields. For example, all of Switzerland’s government bonds have negative yields.

Investors would look for high-dividend or positive-return assets, such as high-dividend stocks, utility stocks, REITs, prudent industrial and blue-chip stocks or bonds that still offer positive returns.

That’s why negative-yield bonds are still sought after by investors, since central banks are set to pump more liquidity into the market or cut interest rates further.

Brexit might trigger many unexpected “black swan” events in Europe.

The share prices of Italy’s two largest banks, UniCredit and Banca Monte del Paschi di Siena, have slumped 60 to 70 percent recently.

Will that lead to another financial storm in Europe?

Investors have already lost their confidence in the ability of central banks to turn things around.

As such, governments have to increase budget deficits or cut back revenues.

For example, the UK already abandoned its 2020 budget surplus target, and Japan decided to delay a scheduled sales tax increase.

The next president of the United States may also expand the budget deficit to stimulate growth. If so, investors would rush to bonds, high-dividend stocks and REITs.

Abundant liquidity could easily distort the market given that global interest rates keep falling and more regions have fallen into negative rates.

Positive returns from rentals would push up property prices even further.

However, things could flip to the other side quickly. That’s why inflation-linked bonds still generate a return of 7 to 8 percent.

The fallout from Brexit could make things even worse and get out of control.

Safe assets are becoming more expensive, and investors may turn to risky assets.

The whole thing is creating the biggest bubble in history. Will the bubble burst in 2017?

Investors should lock in their profits and fasten their seat belts.

This article appeared in the Hong Kong Economic Journal on July 7.

Translation by Julie Zhu

[Chinese version 中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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