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Marcus Brookes: What the Brexit referendum means for markets

21 June 2016

With the UK’s Remain/Leave referendum on its membership of the European Union just days away, the Schroders multi-manager explains what the vote could mean for various parts of the market.

By Gary Jackson,

Editor, FE Trustnet

The looming ‘Brexit’ referendum means that financial markets could witness frequent and violent reactions to data over the coming days, according to Schroders’ Marcus Brookes, who has outlined the opportunities and risks that might present themselves after the vote on 23 June.

The Financial Times has been tracking the various opinion polls on the likely outcome of the referendum in the FT poll of polls. This is now evenly split, with 44 per cent of polls suggesting a ‘Remain’ vote to triumph and 44 per cent saying it will go to ‘Leave’.

The Leave campaign had been gaining ground in recent weeks and took the lead in several polls. Indeed, the FT poll of polls shows that the Leave vote was considerably higher than Remain at the start of last week.

However, the Remain movement started to regain momentum following the death of Labour MP Jo Cox, who was shot and stabbed in Birstall, West Yorkshire, on Thursday.

Brexit poll tracker

 

Source: FT poll of polls, updated 21 Jun 2016

The referendum has been a persistent presence in UK markets since it was announced by prime minister David Cameron on 20 February. Since the start of the year the FTSE All Share has fallen 1.02 per cent (in price performance terms) while the MSCI AC World is just in positive territory with a 0.71 per cent rise.

Speculation has also been rife over the effect either outcome would have on financial markets.

Brookes (pictured), head of multi-manager at Schroders, said: “It feels like this has been a subject of discussion for many months now and like most of the UK we have found it a pretty uninspiring period, with poor arguments presented by both sides. We now find ourselves in the period where it gets interesting, which means financial markets will suddenly react more frequently and violently to data.”

“A vote to Leave would appear to create the opportunity for the biggest dislocations in financial assets, but our observation is that many of the consensus victims have already been quite weak. Clearly they can weaken further, which needs to remain under consideration.”

In the following article, we take a closer look at how Brookes things the referendum could affect the major asset classes.

 

Equities

Over the year to date, the FTSE 100 has fallen 0.61 per cent in price performance terms, while the FTSE 250 is down 2.70 per cent and the FTSE Small Cap ex IT has lost 1.46 per cent. All three were down significantly more but surged yesterday with rises of around 3 per cent being seen.

Price performance of indices over 2016

 

Source: FE Analytics


“The consensus believed that UK listed companies with high levels of UK revenue would be under threat. It is hard to disentangle the UK stock market from broader global trends, but a case could be built that FTSE 250 and FTSE Small Cap weakness year-to-date has been in part due to their greater exposure to UK domestic companies,” Brookes said.

“The FTSE 100 benefits from having internationally-exposed companies, particularly commodity-related companies that have done well recently, but that factor can be observed globally, not just in the UK, so it would be expected that this area should outperform in the rebound in markets.”

When it comes to individual sectors, the multi-manager notes that the FT’s survey of strategists and investors in May found that banks, retailers and construction would be those at greatest risk of struggling in the event of a Leave vote.

While the FTSE All Share Construction & Materials index is up 0.54 per cent, the FTSE All Share General Retailers index is down 8.81 per cent and the FTSE All Share Banks index has fallen 14.09 per cent. As mentioned, the FTSE All Share is down 1.02 per cent.

“Perhaps both of these sectors now have a good deal of pessimism already priced in, meaning again that the better risk/reward might be to add to this area,” Brookes said.

“Worryingly though, it is just as plausible that this observed weakness is a signal of a more serious UK economic slowdown that is emerging irrespective of the EU vote.”

 

Fixed income

Brookes has been cautious on fixed income for some time now, arguing that low interest rates and low growth expectations mean that government bonds are now “far too expensive”.

“Again, a consensus had been built that a Leave vote would be bad for UK government debt (foreigners less willing to finance UK deficits) and corporate debt (recession fears would undermine confidence in default rates),” he said.

However, he added that it is “interesting to observe” that 10-year gilt yields came down from around 1.5 per cent to low of 1.11 per cent as the Leave campaign became stronger in recent weeks, which is not what would have been expected. They have moved back to 1.25 per cent since.

Performance of gilts over 2016

 

Source: FE Analytics

“It could be that domestic investors have reduced their exposure to higher risk domestic assets (UK equities, UK property etc.) to hide in relatively secure UK government debt. This could imply that the move following a Remain vote could be pretty painful for UK gilts, which had stood at just under 2 per cent at the beginning of the year, so yields have a long way to rise to get back there (creating attendant capital losses),” he said.


“Whatever the outcome of the vote, 1.11 per cent is not a yield that looks remotely sensible given our current views; we would have to subscribe to Project Fear’s doom and gloom predictions to believe that this offers value: in other words, disinflationary bust in the UK economy, in which case equities are the bigger risk.”

 

Currency

Much attention over recent months has been devoted to sterling and the potential implications of a vote to leave the EU.

“A consensus emerged in the currency markets that sterling would be weak due to worries about the possibility of the Leave campaign working,” Brookes said.

“This view was too simplistic for us, particularly as sterling had been $1.58 in June 2015 and stood at $1.38 in March 2016, so substantial weakening had already happened months ahead of the date of the vote. At the time of writing, sterling is at $1.41, not what the consensus would have had us believe.”

Performance of sterling against US dollar and euro over 2016

 

Source: FE Analytics

The potential consequences of a Leave vote for the pound returned to the headlines again this week after noted currency speculator George Soros, who famously broke the Bank of England in September 1992 after a $10bn bet against sterling, warned it could spark a ‘Black Friday’.

“Sterling is almost certain to fall steeply and quickly if Leave wins the referendum,” he told the newspaper.

“I would expect this devaluation to be bigger and also more disruptive than the 15 per cent devaluation that occurred in September 1992, when I was fortunate enough to make a substantial profit for my hedge fund investors at the expense of the Bank of England and the British government.”

 

Brookes’ full comments, including his views on how to look at polling data and bookies odds, can be found here

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