UBS: Brexit. What now?

Brexit. What now? The UK has spoken. By a margin of 52% to 48% the UK public has voted to revoke its membership of the European Union. Prime Minister David Cameronhas resigned. However, the invoking of Article 50 of the Lisbon Treaty is on hold while the leading lights of the Conservative party position themselves for the leadership battle. The main UK opposition party, Labour, is similarly riven with in-fighting post the Referendum. In short, next steps for the UK are unclear and UK political dysfunction may be higher than most investors will have accounted for.

With all this as a backdrop the reaction of markets on Friday was, in our view, surprisingly benign. Moves were at the very low end of scenario stress tests.There was certainly little evidence of any Lehmans-style panic, distressed and indiscriminate selling or liquidity crunch. Overall, capital markets appeared to be functioning fairly well.

So why has the reaction to-date been so muted to an outcome so few predicted? We believe that despite a high level of conviction that the UK would remain in the EU, hedge funds and long only investors were running low risk levels overall coming into the event – and particularly low risk to Brexit - sensitive assets.

But in truth we believe that many investors are simply still digesting the ramifications – in terms of politics, in terms of economics and in terms of markets. At the best of times the impact of politics on markets is often difficult to quantify. Right now even the political implications are unclear. We expect the EU to take a hard line with the UK in trade discussions in order to reduce the prospect of further country exits. Based on our analysis, we see the impact on the UK economy over the next year or two as materially negative.

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