After the referendum about Britain leaving the European Union, financial markets faced unexpected results. Although there were signs that the final counts would be quite close, most polls showed that the leading party is the one voting to remain. But unlike most of the experts and financial analysts anticipated, almost 52 percent of the British population wanted to leave the EU. This event was about to impact the markets in a way that the analysts could perhaps know a trend of, but it was not altogether clear what would really happen to financial markets afterwards. This ambiguity of expectations was present due to two reasons; firstly, no country has ever left the European Union before, and secondly, the actual agreements about what it really means for Britain to leave the EU was not yet arranged. One thing was sure, it would have, to some level, negative effect on the Sterling, on the UK stock market and pretty much on everything that is linked to the UK economy. If not for the fundamental reasons of real impacts of Brexit to Local and Global Economy, then at least short-term for the negative sentiment in the financial markets.
Immediate markets’ response
The UK sterling fell down by over 11 percent to US dollar and has yet not recovered from those levels. It dropped by 7,1% the very next day after the UK vote which was the largest one-day decline recorded, after 4,1% plunge in 1992 on Soros’s phenomenal bet against Sterling. But markets got volatile in general, UK’s FTSE (Financial Times Stock Exchange 100 Index) declined by 5,6% in next two trading days but the same happened to American S&P 500, German DAX sank even more by over 9% in two days. All these slides show the market’s mood and its response to all the negative hypothetical scenarios about what might happen if Britain leaves the EU. Another indicator that signals investors’ uncertainty is their appetite for gold. The price of gold increased between 23rd June to 8th July by 8.6%, and has reached its peak since March 2014. Most of these assets got corrections in later trading days persisting in higher volatility.
During the time of unsteady markets, Hedge funds seek more investment potential than on usual “calm-water” periods. However, hedge fund managers who participated in the event of the Brexit referendum would first have to correctly predict the result of the referendum in order to earn some money from it. This was mostly not the case. Even Mr. George Soros made a statement before the day of the vote that the Pound would drop if the British voted for exit. And they did, and the Pound did drop but Soros and his Quantum Fund lost money on this bet, since he, as many others, believed that Britain would vote to remain.
Computer-driven strategies outperformed human managers
According to Hedge Fund Research (HFR) industry indices, overall hedge fund market was down by 18bsp on June 24th the day after the vote. However, trend-following automated strategies were up by 71bsp the same day. But this was not because they figured how Britain would vote in referendum but because these algorithms could detect the trend soon enough to earn some return on it, or more specifically not to lose money on it.
FTSE 100, positive numbers?
After the first shockwave faded, it is even more clear that Brexit has a negative impact on British economy. The British Pound cannot recover from its historic lowest levels, the Bank of England cuts interest rates to 0.25% and downgrades GDP forecast admitting potential return to recession first time after the financial crisis. All three major rating agencies downgrades UK credit rating. So why the FTSE 100 (UK stock index listing 100 of major UK-based corporations) goes up?
From 27th June, after two-day stumble, the index has steadily gone up by almost 12% to its 14 month high. This paradox situation has its fundamental reason. Firstly, Corporations listed in the FTSE 100 are mostly huge companies running the business on a global market. In fact, about 70% of their sales comes from outside of the UK, so local economy problems do not impact them so much. Moreover, and this is the second reason of the FTSE climb, 70% of outside earnings are converted into cheaper pounds making the profitability of these companies upward. Let’s not forget that the plunge of the local currency, in general, increases the purchasing power of importing countries, boosting the sales even more.
Many hedge funds did not place any bet prior to the referendum considering the level of uncertainty of the results. But those that guessed it right or took the action promptly enough did book the tangible earnings.