With Britain voting to exit the European Union, the confi dence that investors, businesses and consumers have in the future economic outlook has become clouded. These uncertainties alone will likely restrain economic activity worldwide and force major central banks to maintain accommodative monetary policies. As such, the threat of a Federal Reserve tightening in 2016 has been substantially reduced and the US dollar could reassert its safe-haven properties. There was already little pressure on the Bank of Canada to move rates higher and this event will reinforce that stance. It may even precipitate a more accommodative approach depending on how the global economy develops.

As far as the UK is concerned, the chances of a UK recession over the coming year have risen. UK real GDP growth expectations had already been revised down to 1.9% in 2016 from 2.3% in 2015 as we approached the referendum. A preliminary assessment is that a Brexit shock could weaken the UK’s growth outlook by 0.5% to 2% percentage points over the next year given the impact on consumer and corporate spending behaviour. Economic uncertainty is being compounded by political uncertainty following the resignation of the Prime Minister, the possibility of a General Election this year and calls in Scotland for another independence referendum. The decline in Sterling on the back of Brexit is acting as a shock absorber for the UK economy, helping to ease fi nancial conditions, but going forward we will also have to see if credit conditions for UK companies tighten signifi cantly. The Bank of England will continue to maintain ample liquidity to the banking sector, with the potential for credit easing measures if fi nancial conditions begin to tighten materially. Policy rate cuts (from the current 0.5%) are also a likely policy response in the short term.

While we were aware of this potential outcome and have been considering the risk for some time, this nevertheless came as a surprise. In fi xed income portfolios, we took a number of risk mitigating actions since the start of the year to cope with high geopolitical uncertainties, including Brexit. These actions impacted duration, curve and credit positioning.

Equity markets have quickly moved to factor increased risk into entities which have exposure to the UK or Europe, particularly large multinationals. Our Canadian and US equity portfolios have felt some stress in their holdings of Financials (Banks and Insurance Companies) although overall they are weathering this storm relatively well in comparison to their European counterparts. The Financial sector is under duress as interest rates have fallen and the expectations for Central Bank hikes are off the table. The allocation to gold stocks in our Canadian equity portfolios was increased leading into the referendum, and they along with better yielding REIT issues have performed well. Our International equity portfolio is signifi cantly under-exposed to the Financial sector and this has been a strong source of relative value add. This positioning was established well before the UK referendum, driven from fundamental research and the challenge to fi nd stable earnings growth within this sector.

Markets have a tendency to over-react to uncertainties in the short run and struggle to understand the implications in the long run. The primary concern is that the long-term political implications of the vote are signifi cant and might signal the beginning of the end of the EU as we know it. That being said, markets are probably overreacting and we might see some interesting opportunities in markets in the near term.