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Building Walls To Freedom

Jun 24, 2016


In our June 6th commentary, we wrote:

A Summer of Global Event Risk

  • We advise caution on deploying new capital
  • We advised the rally was weakening
  • We advised our technical models suggested weakness ahead
  • We advised markets were complacent and were entering a period of event risk
  • We advised investors consider their risk exposures

You can re-read our commentary titled “Complacency, Event Risk & Bull Markets” here.

Having been cautious ahead of the event, we now ask “What is the extent of the damage that Brexit can inflict?”

Building Walls to Freedom

Many years ago, the Berlin Wall came down and a great experiment started. Today, the British people have spoken that proximity works when ideologies sync. Immigration works when cultures sync. Democracies work when democrats rule, not bureaucrats. Wall building is back in vogue in the U.K. and possibly U.S. and other European countries.

We frankly think wall building is a step in the right direction. A step away from non-elected bureaucrats determining the direction of the world economy. A step away from centralized power in Brussels. A step away from carte blanche quantitative easing, negative interest rates, and helicopter money. A step towards a more stable global economy.

Banking System Vulnerabilities

The follow on implications are obviously what happens to the banking system, global trade, trade agreements and global demand. These and many other issues will be discussed in coming days, weeks and months. As countries realize that supermarkets are still stocking goods in the U.K. and ATMs are working, the momentum to leave the European Union is likely to build. We’re already seeing demands for referendums from France and Netherlands.

What becomes of stressed institutions in the European banking system? What’s the impact on corporate earnings and end user demand? An exit creates solvency issues for some companies in the European banking system. We believe global central banks are well aware and will provide liquidity. A coordinated intervention by global central banks is on the anvil if necessary.

The follow on question is what of the Indian banking system. Unfortunately, our banking system is somewhat vulnerable to a banking crisis. Particularly, it is the exposure that our PSU banks hold in certain multi-nationals that we’d be concerned about. However, the government stands ready to bail out and stand behind the sector.

Leverage, Flight to Safety & Flows

Is the world – or India – coming to an end? Looking out on the bustling business happening around us, that is certainly not the case. Any transmission of impacts will likely occur through the capital markets.

The trigger reaction today is a flight to safety, which currently is into U.S. treasuries and out of emerging markets and Europe. Ironically, developed markets globally are sitting on the largest vulnerabilities while markets like India are demonstrating healthy growth.


India remains a domestic consumer focused market. As we detailed in our commentary on June 6th, Indian exposure to European markets is roughly 20% at best with exposure concentrated in certain sectors such as IT, Pharma and Autos.

We’d expect a marginal reduction in earnings estimates as a result of the news. We’re not of the opinion that the immediate impact is significant as the negotiation process will take a long time, in the order of months. The longer term implications of a breakup of the Eurozone will be pondered in coming days.


Euro Stoxx 50 futures are indicating a large down opening. Further calls for referendums are already underway out of the Netherlands and France. The implications for the European banking system are certainly worthy of serious consideration.

We’re not seeing huge volume flowing out of the Indian Equities market this morning. We’re also not seeing huge movement in the domestic currency.

A month ago, when markets were buoyant, we were cautious. Markets were complacent and we were concerned. Today, markets are concerned and we prefer to start thinking constructively.

We’ve seen in the past few months that domestic inflows have remained buoyant even as FI flows have been heading back overseas. We believe Indian markets will be supported by domestic flows going forward and earnings growth will come out of our domestic economy.

As the European Union heads to its possible demise, a new order is rising. That new order is the rise of Asia. The implications of today’s vote will take months to resolve. For clients with the appetite to withstand volatility, a gradual, phased deployment to buy is the right approach to investing in risk assets, using days like today to add incremental exposure.

In the longer term, opportunities where fear is high should be used to accumulate positions. We advise accumulating assets with a deployment map that our wealth managers will lay out given particular risk profiles and allocations.