The 8216 Brexit trade 8217 bites back

Tuesday brought the first major upset for ‘Remain’ campaigners in a month, underlining that it’s far too early to unwind the pro-Brexit trade just yet.

An ICM phone poll out on Monday was 45% / 42% for Brexit.

ICM simultaneously released an online survey which showed a pro-Brexit result too: 47% vs. 44%.

It came after an ORB/Telegraph poll on Monday evening showing ‘Remain’ at 51%, five percentage points ahead of ‘Leave’, but sharply off the 13-point lead seen last week.

These latest indications gave the pound its worst afternoon since early May, leaving cable a hefty 2.6% off Tuesday’s highs.

What was bad for the pound was better for the euro, sending it to its highest against the dollar for about a week.

It was also telling that the cost of protecting foreign exchange in both currencies spiked as well, having fallen sharply over the last few weeks.

Tuesday afternoon’s developments back our view that whilst UK stock markets have regained some poise in the past month in step with the ‘Leave’ camp losing its own, it’s too early to jump back into British shares.

We summarise our reasons for this view below.

• The world’s largest investors are still not particularly enthusiastic about UK equities: Brexit risk was by far the biggest cited by fund managers polled by Reuters in recent weeks. That confirmed observations by Bank of America Merrill Lynch from earlier in the month. The US bank said investors slashed UK equity holdings to the lowest level since November 2008
• The FTSE 100 and FTSE 350 continue to hover over the flat mark for the year and further upward progress before 23rd June looks set to be as slow as it has been in the year to date
• As for the pound, its early-May rebound was at least partly a function of the dollar’s grinding months of consolidation—now that the dollar is looking on firmer ground (three straight weeks of gains) a clearer picture of sterling strength may be possible
• The speculative picture bears closer scrutiny as well: the cost of longer-term sterling hedges is still more than 40% higher since January, even after falling sharply since mid-April.

In other words, imagine a large British firm needed to protect the value of cash in sterling for the next three months. Including transaction fees, the outlay required would be almost double from the beginning of the year.

That said, it was 25% less expensive on Friday to protect sterling holdings for three months than in mid-April.

We would therefore expect corporate treasurers to be tempted back into protection trades as the countdown to Brexit vote continues.

Additionally, we also spied currency speculators with the highest risk appetite giving the game away last week: trade in shorter-term sterling options was surging.

As for the comeback of stock market sectors perceived to be under Brexit pressure, these rebounds have been uneven.

At the same time, outright pro-Brexit trades are still the biggest winners of the year on average.

In conclusion, whilst the risk-reward balance in ‘Anti-Brexit’ stock trades has improved in recent weeks, we would advise smaller-scale investors and traders to remain as wary as we know global players are.

There will be many more scares for the ‘Remain’ camp, including those in the market betting on that as the likeliest outcome, and Tuesday afternoon’s sterling gyrations are a case in point.

On that basis, we would rather eye stock hedges (perhaps with CFDs) aiming to capture rebounds over the last week or so of between 4%-8% in some of the worst performers of the year, like RBS, Barclays, and Next, rather than outright buying at this stage.