While the polls predicting the outcome of the Brexit vote have dictated investor sentiment and the direction of financial markets over the past couple of weeks, in realitythe vote does not spell immediate changes in economic fundamentals for the UK, says Old Mutual Investment Group: MacroSolutions portfolio manager John Orford*.
That said, a vote to leave the European Union (EU) – or even a narrow margin in favour of remaining in the EU – would likely mean further uncertainty and could very well see the collapse of the David Cameron-led government.
In anticipation of the vote, however, equity market volatility, as measured by the VIX Index, the world’s fear gauge, has spiked above 20 for the first time since February and most developed stock markets, as well as the JSE All Share Index, shed a couple of percentage points last week. Equity markets have since rallied on indications that the weight of evidence in polls is that voters are leaning towards staying in the EU.
But what is the likely impact of a “remain” or, alternatively a “leave”, vote on financial markets? Orford says in the event of a “remain” vote, markets are likely to be relieved, with the Pound and domestically-focussed UK stocks benefitting. This could see gains in UK property stocks including locally listed Intu and Capco stocks, consumer discretionary stocks and financials, which have all lagged the broader UK market in the run up to the referendum.
A “leave” vote, while not having an immediate impact on the economy, would probably set back the financial markets, particularly now that investors appear to be anticipating a “remain” vote, and this could result in a weaker pound and global sell-off in equities.
In the medium-term, what exactly a “leave” vote would mean is uncertain since legally a vote by the UK parliament would be required to leave the EU. Even subsequent to a Parliamentary vote to leave the EU, there would be a two-year period during which the UK and the EU would negotiate an exit agreement, which would determine trade market access and freedom of movement. Orford’s base case in the event of Britain leaving the EU is that UK will be able to negotiate a free trade agreement and thus leaving the Eurozone could have a more limited impact on the macro-economy than some commentators suggest.
However, if weaker sentiment and a weaker pound in the event of Brexit resulted in a weaker UK economy, then Orford expects that UK-listed equities, such as property stocks, domestic retailers and banks, to be most adversely impacted. Those companies that are listed in the UK, but which generate earnings outside the UK, should be less negatively affected and might benefit if the pound were to weaken. These include the mining counters and consumer staples, like British American Tobacco.
Orford says Britain leaving the EU is an important, but local, event and is unlikely to have a major impact on the global economy. Far more pressing is the fact that the global economy is already very weak, with growth of 2.5% at best and much lower than growth during the 2000’s. Other concerns are China’s unpredictable economic outlook, ongoing uncertainty about when the US Federal Reserve will again raise interest rates and pretty weak corporate earnings across the world.
The most important consequence of the UK voting to leave the EU is that it would reignite the possibility of the Eurozone breaking by fuelling national discontent with the European Union and Eurozone. The Eurozone economy is much more resilient than it was in 2012 when the Greek debt crisis threatened its survival. However, a vote to leave the EU by the UK would certainly fuel the growing trend in politics to favour nationalist over global interests.
Brexit vote has now happened: What we now know
- The Referendum has resulted in a vote to leave the EU, by a relatively narrow margin of 52-48.
- UK Prime Minister David Cameron to step down.
What we could see over the next few months / year:
- A possible shallow recession in the UK in the second half of the year
- The Bank of England (BoE) to ease rates significantly (more quantitative easing), unless the ongoing fall in sterling becomes large (already lost 10% overnight against the USD).
- The euro area economy to slow, but not as severely as the UK. Expect GDP cuts.
- The ECB to attempt modest further credit easing.
- A period of political turbulence in the UK. Prime Minister David Cameron to step down.
- Additional political stress in the Eurozone – Next year sees general elections in France and Germany.
- Big implications for immigration & labour movement (>1.2m Brits living in the EU) Breakup of the UK? England, Wales, Scotland, Northern Island