Market News & Analysis

Prepare for market aftershock, Brexit or not – Part 2

Part 2 of our post-referendum market outlook focuses on a ‘Brexit’ scenario. Part 1 assessed the likely impact of a ‘remain’ vote.

 

LEAVE

 

The impact on the market from ‘Brexit’ won’t necessarily be the inverse of the one we expect from ‘Remain’.

That’s mostly because weakness we’re now seeing in the pound, the euro and in British and European stocks already partly prices in negative impact from a ‘Leave’ outcome.

But, even taking into account substantial bearishness already booked into the pound, complacency has been the market’s default position for weeks.

It suggests a level of unpreparedness for Brexit, that makes shock and awe all but guaranteed.

With just 20 days to go before the referendum, options pricing for the date is becoming an increasingly unreliable guide for how far the pound might fall.

 

 

However, a crash of as much 10%-15% by the pound against the dollar could still be on the cards if the 20 cent move suggested by some options is realised.

 

By contrast, euro/sterling will jump, albeit probably by a lower amount. Regardless of the one-day advance though, expectations of a stronger dollar, hand in hand with at least one Federal Reserve interest rate hike by the end of 2016 should seal pound and euro fates in the months that follow.

Also consider the 30%-plus drop in the Bank of England’s Sterling Currency Index between late January 2007 and January 2009, which followed the financial crisis. That suggests the pound could take at least two years to stabilise post Brexit.

Our pro-Brexit short equity portfolio would look cleverer if the event actually happens. Declines by retailers and life insurers which scraped 30% for the year-to-date by February will be reloaded in the first post-Brexit week.

Since other sectors withstood Brexit fears better, their shares may decline more moderately immediately after. We would then expect investors to become more selective as the initial shock is absorbed. Well-run companies with good cash balances, such as NextAviva and housebuilder Berkeley Group would differentiate themselves in the medium term by relatively swift rebounds. We would expect Lloyds and possibly Barclays, to recoup faster than RBS.

 

If the UK votes to leave the EU, stock market tumbles will be much worse in Europe than in Britain.

 

We expect a 10% rout at worst for the DAX.

However, the main stock market of Europe’s growth engine, Germany, has a better chance of a fairly quick rebound than Britain’s FTSE.

In all probability, with Britain outside the EU, losses for the year by UK stock indices will accelerate. The FTSE will post its third consecutive annual fall. At best, the benchmark will end the year near lows seen in February, down 11.5%.

 

Key takeaways

  • Expect a grim and extreme impact on markets from a Brexit.
  • A sharp deterioration in sentiment will be offset by sterling and stock market falls already seen in lieu of the actual event, but only temporarily.
  • Sterling’s post-Brexit decline will probably be as deep and sustained as the one that followed the financial crisis.
  • Once the vote is out of the way, Brexit is unlikely to have a lasting negative impact on all shares in sensitive sectors, even if uncertainty over the UK’s ability to trade with Europe and beyond weighs on the economy for years.

More From Ken Odeluga

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