As both sides square up to each other in the final countdown to the “Brexit” vote on 23 June, UK bookmakers have made the “Remain” camp firm favourites to carry the day and for Brits to wake up on the morning of the 24 June as ongoing full members of the European Union.
But is it such a dead cert? And will that put the matter to bed, or will there be, as Sir Vince Cable argued in the Peterhouse “Brexit” debate recently, the danger of a state of “Neverendum” in which, like Bill Murray’s character weatherman Phil Connors in the movie “Groundhog day” we wake up, whack the alarm clock and go, oh no, it’s that referendum guy banging on again about the intricacies of the single market and the texture of French sausages or horror of horrors, whether or not we’d be allowed back into the euro vision song contest alongside Australia and the Ukraine.
In this week’s blog we explore the current state of the polls, and likely investment ramifications of the vote whichever way it goes.
We highlight certain aspects you may not have thought of and also attach the link to the you tube video of that “Brexit” evening Peterhouse hosted earlier in the month.
UK bookies are in the “Remain” camp
Implied odds make it a likely 55/45 vote in favour of “Remain”, which would coincidentally be the same margin as the Scottish vote just 21 months ago in September 2014. Referenda are by convention biased towards the incumbent, with the advantages the proposer has of the levers of state and support of its civil service. So it would in fact be surprising if “Remain” were not ahead at this stage…
But in a two horse race the favourite can always fall…
In contrast to the bookies, pollsters report only a small net lead for “Remain” with several giving the leave camp an an edge. Britons have historically been among the most euro sceptic of Europeans, not being among tbe founding six in the Treaty of Rome in 1957 and only joining what was the old EEC in 1973. For all the machinery of state at its disposal the vote remains tight…
And I wouldn’t start from here…
Former UK Chancellor of the Exchequer and prominent “Leave” campaigner Nigel Lawson asks whether we would join the EU today were we not an existing member and while it’s true this is not the present situation it is nonetheless the case that there is little enthusiasm about the European project in the UK.
There may be trouble ahead…
Irving Berlin’s classic line in the song he wrote for the film “Follow the Fleet” ,”Let’s Face the Music and Dance” spoke of trouble ahead and whatever the result unfortunately for those of a Tory leaning, things may not be easy for the UK’s governing party.
The political knives are out for David Cameron it seems with one Tory MP apparently reported by the Sunday Times as saying ‘I don’t want to stab the prime minister in the back — I want to stab him in the front so I can see the expression on his face… You’d have to twist the knife, though, because we want it back for [George] Osborne’.
Whatever the referendum result the turmoil in the Tory party looks likely to become an everyday feature of UK domestic politics.
Are David Cameron and Jeremy Corbyn secret “Brexiteers?”
And it doesn’t help the “Remain” cause when party leaders are not exactly banging the drum themselves for the EU. Former Cameron adviser Steve Hilton may have been exaggerating last week when he claimed Cameron would vote for “Brexit” were he not PM but Labour leader Jeremy Corbyn has been almost entirely absent without leave when it comes to endorsing a “Remain” vote, unsurprising given his historically lukewarm view towards the EU.
Against this background we take a look at likely implications for investment markets…
What would an ‘Out’ vote mean for equities in general?
Politics aside, markets are driven by many factors – macroeconomic, geopolitical, the strength or weakness of individual companies and so on. So far in 2016 a raft of economic factors have impacted markets – most notably the fall (and subsequent rise) in the oil price, fears of a growth slowdown in both China and the US, and worries over the effectiveness of major central banks to stimulate growth .
The FTSE 100 index is made up of companies, over 50% of whose earnings come from overseas, for example miners, energy, and oil, and it is factors such as the oil price, and the prices of commodities more generally, rather than ‘Brexit’ fears, that are the real drivers of these companies’ valuations.
The obvious beneficiaries of a weaker pound are UK manufacturing (although the UK is a largely service-based economy) and the tourist industry. Last year the UK ranked eighth out of ten in the most visited countries in the world, receiving over 30 million visitors from Europe, the US, China and Japan. The latter countries are well-known for their tendency to buy luxury goods, so this sector could benefit on a relative basis.
But how about an ‘In vote’?
Since the start of the year companies such as housebuilders, leisure companies, retailers, and support services, where earnings are generated within the UK, have underperformed the UK benchmark by around 10%. Should Britain decide to remain within the EU, the consensus is that we would see a bounce in ‘UK plc’ stocks.
Currency markets – where most of the drama will be played out
Should the UK decide to leave Europe this is likely to lead to falls in sterling relative to other currencies. When Boris Johnson threw his hat in the ring for the ‘Out’ campaign, sterling relative to the US dollar fell to a closing rate of GBP/USD1.39, the lowest level since June 2001. Some analysts think the pound could fall to GBP/USD1.20. Should we choose to remain, however, we can expect a small rally in sterling but nothing like, we believe, to the level of GBP/USD1.72 in May 2015. The struggle to reach last year’s highs reflect the UK’s burgeoning current account deficit – in effect we import more than we export – which is currently around 7% of GDP. This compares to Germany and Italy which have trade surpluses and France which has a small trade deficit.
And what about business investment and M&A activity?
One of the main fears in board rooms is the negative impact of delaying capital expenditure plans and negatively impact growth, at a time when UK productivity is already low. Latest figures from the CBI5 confirm this is indeed occurring with capex having slowed in the last three months. In the event of a ‘yes’ vote we would expect companies to resume capital expenditure plans and unfreeze any delayed business spend plans. We would also expect further listings of UK smaller company shares (IPOs) to materialise in the second half of the year.
What would “Brexit” mean for European equities?
Should the UK decide to leave the EU this would set an interesting precedent for other members of the European Union where the desire for greater autonomy and independence from Brussels is increasing it seems. The ensuing uncertainty of a ‘Brexit’ fall-out would SURELY put pressure on the euro as commentators speculate whether or not the single currency can survive without a concerted drive to political unification as former Bank of England governor Mervyn King argues in his new book. We would be rather cautious on the outlook for European shares in the event of a “Brexit.”
Multiple theories abound as to what would happen to gilt yields in the event of a ‘Remain’ or ‘Out’ vote. Despite some rise in gilt yields at the beginning of the year, since February, UK gilts at the longer end of the curve (10-15 years) have traded in a remarkably narrow range. It would appear that the investor uncertainty we witnessed in the first three months of 2016, where fears of a slowdown in China growth leading to possible worldwide recession, have helped to reinforce gilts as a safe-haven asset. The two potential outcomes for gilts are:
A ‘Remain’ vote, with the lifting of business uncertainty leading to a normalisation in interest rates, and lifting gilt yields higher in the process.
An ‘Out’ vote could, on the other hand, spur Bank of England officials into injecting extra liquidity into the system, to avoid any crisis of confidence, prompting bond buying and a further compression of yields.
Intriguingly, In terms of possible bond market hedges, index-linked gilts could do quite well, in our view, if “Brexit” happens because a sharp fall in sterling will almost certainly feed through to an increase in inflation.
Fears over the EU referendum vote may have acted as the catalyst for investors who were already nervous of the London property market in particular on account of heady valuations.
London alone accounts for more than 20% of European cross-border commercial property investment – and an eye-watering 50% or more of Asian investors’ transactions over the past five years, according to Real Capital Analytics.
Plus ca change…
And when all the debating/argument is over and we either have a new relationship with our European partners or not, we’ll still go back to admiring the Germans’ ability to make cars and the French ability to make the best champagne.
Either way, the euro 2016 football will probably be won by France, Germany or Italy and football still won’t be coming home for another 50 years, but at least it will get us all together again following what’s been a bruising three month EU referendum campaign.