Today, the UK goes to the polls to vote on whether to remain in or leave the EU. Our worry from a negative outcome of this is how it would affect our investments. We are confident that there will be no contagion, and a stress test analysis of our portfolios shows an approximate 2 to 3% drop should polls show an unfavourable result. In any case, our core fund – United G Strategic - has already sold some risky assets at the beginning of the month and is currently holding approximately 25% cash as buffer just in case. Our key message is that our risk analysis and Risk Matrix are currently not showing undue stress in the markets. With so many investors already positioned for a negative outcome, the impact on markets would likely be muted and there could be a high possibility of a relief rally should Britain vote to remain in.
In or Out?
Opinion polls have been making markets gyrate over the past few weeks. The latest polls appear to show that the result is poised on a knife’s edge (Fig 1). However, if you look at betting odds, the bookmakers are not pricing in a UK exit at all and the latest odds are pricing in a 20% probability of a BREXIT (Fig 2). Gamblers put their money where their mouth is, and we tend to believe them in this instance as the bookies likely have a better feel of how the vote would turn out – which would be for the UK to remain.
Fig 1: Opinion Polls Show a Close Race
Fig 2: But Bookies Are Not Paying If You Bet For UK to Remain
What Is the Cost of UK Leaving?
Getting down to the heart of the matter, nobody really knows. Depending on which newspaper or website’s analysis you read, you will be inundated by a whole trove of meaningless statistics. The real impact on the UK economy, EU economy and the rest of the world will only be known after the renegotiation of over 100 existing and new free trade agreements. Even if the UK votes to go out, it opens up a two year long process of negotiation between the UK government and the European commission with some finality only in 2018/19. However, from some data shown below, we can safely say that EU membership appears to have benefited the UK in the long run and with the EU as an important trading partner, leaving the bloc could have some negative impact on the economy (Fig 3, 4).
Fig 3: UK Growth Likely Benefited from EU Membership
Fig 4: The EU is the UK’s Largest Trading Partner. A Renegotiation of All Trade Agreements Should an Exit Occur Will be Long Drawn and Negative For the Economy.
What Are Markets Saying?
Markets do not like uncertainty, and for sure, we have seen some pricing in of the possibility of a BREXIT scenario. The big movements were seen in the currency markets, where the volatility of the pound spiked to high levels and generally weakened against most major currencies (Fig 5). UK equities have also underperformed since Apr 2016, both in absolute and relative terms versus the global equity index as managers sought to reduce their holdings ahead of the vote. UK stocks have also traded at a large premium over the rest of the Eurozone for the past 5 years but this gap has been narrowing recently due to investor fears (Fig 6). With so many investors already positioned for a possible BREXIT, we see a reduced impact on markets if the outcome is negative and a high possibility of a relief rally should Britain vote to remain in.
Fig 5: GBP Volatility Has Been Elevated In 2016 and Recently Leading Up to the Vote
Fig 6: UK Stock Market Premium Over Eurozone Has Been Narrowing As Investors Reduce Their Holdings