Brexit or Bremain, the outcomes are polar opposites for risk asset markets and today I want to run through what this all means ahead of the UK referendum on the 23rd of June.
Firstly, make no mistake, this is turning into a MAJOR market event. Either outcome will move markets sharply and we need to be prepared for volatility. I did write recently to you that I had built up cash levels waiting for a pullback, and I did point to Brexit as one of the reasons for building up cash and waiting for better risk adjusted entry prices.
This is NOT a game like Grexit, that was always going to end with Greece folding and markets bouncing. This is a genuine 50/50 chance in my opinion and that is how I am positioning my portfolio. No outcome is certain and arguably the only certainty is volatility ahead of and after the referendum. If anything, recent opinion polls show the Brexit camp pulling ahead and bookmaker odds, while still favouring Bremain, have narrowed a notch.
It’s worth remembering the referendum is NOT a compulsory voting situation and occurs on a Thursday, again decreasing the forecastability of the event, as voter turnout is unknown. It’s also potentially a vote based on emotion rather than economics and that makes it a potentially dangerous event for market participants.
This has clearly already had an effect on risk markets, with risk premium increasing as investors scramble for perceived protection/de-risk portfolios.
Since I wrote to you last week, world developed long-term bond yields have dropped further, to levels never seen before. The German 10yr Bund joined the “negative” club this week, a development I still can hardly believe. But that negative 10yr German Bund yield is trying to tell you how concerned European investors are about the potential for Brexit and its ramifications for the entire European union.
The US Dollar, Swiss Franc, Japanese Yen and Gold have all also rallied. These are traditionally considered “haven” assets while it’s also worth noting the VIX index (aka the fear index) has risen sharply in New York.
This combination of cross-asset class movements is telling you that the investing world is now taking Brexit seriously after being nonchalant about it until very recently. What you are seeing is professional investors and hedge funds take some risk off the table and move to the sidelines because of this genuine uncertainty. It’s not just the uncertainty of the UK referendum, it’s the uncertainty of the market response, which creates a “double uncertainty”.
What is also starting to cross my desk are broker lists of “winners & losers of Brexit”. Clearly, the biggest and most obvious loser of Brexit would be the British Pound (GBP). Nobody debates that.
The most common playbook on Brexit occurring was succinctly summarised by Bell Potter’s Richard Coppelson this week. I agree with this high level view on Brexit’s short-term ramifications, if it were to occur.
If UK leaves we could thus see…
- Initially aggressive selling + Hedge Fund shorting UK anything British
- There are fears that the UK equity market could be sold off as much as -10% to -15% as PE derating of up to 10% due to the “uncertainty” plus earnings decline from softer UK GDP.
- UK rates cut need to support to UK economy
- Gold would rally hard
- Volatility would surge
- The pound gets smashed maybe a 15-20% depreciation of the GBP as capital inflows slow plus uncertainty
- There are estimates an exit would see UK GDP fall from 2% to below 1% over the next 12 to 18 months
- Euro lending for the UK would be off the agenda –thus less borrowings available.
- Germany then hitting the exit – they are not going to fund the whole thing.
- We then see across Europe – a round of referendums which could be very destabilising for European financial markets – which could spread across international markets (remember how world markets were held hostage to Greece for so long)
- Going to the back of the line in trade agreements, with partners like the US.
All Australian-based investors need to realise Brexit or Bremain have ramifications for their portfolios and individual stock holdings. This is NOT just a UK/Eurozone issue. Yes, the greatest price impact will be felt there but either outcome will cause global cross-currents that Australia will feel.
From a stock specific Australian listed perspective, it is worth noting the six companies with the highest proportion of GBP revenues. These are the stocks with the greatest leverage, both down and up to Brexit or Bremain. These six stocks are basically for the next week or two going to trade as leveraged derivatives of Brexit or Bremain.
- Clydsedale Bank PLC (CYB) 100%
- BT Investment Management 63%
- Henderson Group PLC (HGG) 61%
- Westfield Group (36%)
- Iress (IRE) 34%
- QBE Insurance (30%)
Clydsedale Bank, BT Investment Management and Henderson Group have already started falling as the opinion polls moved in favour of Brexit. Clearly, they would fall further if Brexit was confirmed, but so too would equity indices as a whole.
On the other hand, because they have fallen sharply into the referendum, and may well fall more next week as we get closer to the event, CYB, BTT and HGG will have serious upside leverage if Bremain is confirmed. Bremain would be a major ‘buy the fact’ event in these three ASX listed financials and they would be the first three stocks I would buy if it appears Bremain is occurring.
Unfortunately though, this is a black or red bet. While most fund managers are de-risking into the event, it’s almost impossible now to place a big directional bet on either outcome. It appears genuinely too close to call but it’s clear the Brexit camp has momentum on its side. That doesn’t mean they will win, but they currently have momentum and that is what investors all around the world are currently nervous about.
As a fund manager, I can’t bet my investor’s money black or red. That’s gambling, not investing. Neither should you be betting black or red on the UK referendum. What I’m trying to tell you today is this is turning into a MAJOR market event that could see a correction or a serious relief rally. I realise that appears to be a fence sit, but this is truly too close to call and SHOULDN’T be gambled on.
The good news for Australian investors is the ASX will be OPEN on Friday the 24th as exit polls/results start filtering out. The rest of the world will be closed and at least as Australian-based investors, we will get live markets to deal in instantly on whatever the outcome is.
My approach to this is NOT to come in with any preconception other than a solid cash holding, which I can choose to deploy or not on the morning of the 24th of June.
This is a classic “think global, act local” event. If common sense prevails (which is no certainty at all), and Bremain is confirmed, then my advice would be to buy CYB, BTT and HGG early on the morning of the 24th. If Brexit is confirmed, keep you powder dry and we will look for better buying opportunities in what would almost certainly be a global equity market sell off, led by the UK and Eurozone.
Either way, fasten your seatbelts friends, the next week is going to be bumpy, but potentially full of opportunities….
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.