If we stay or if we go.

Investment Notes

It has been our long-standing expectation that the UK will vote to stay in the EU at the referendum on Thursday 23 June 2016. This judgement has been based on the belief that the British electorate is internationalist in nature and would respond to the exhortations of political leaders to continue with EU membership. Some recent opinion polls have tested our confidence, however, and financial markets have reacted to the growing unpredictability of the result; sterling and stock markets have been volatile. Investors appear to be concerned a “Leave” vote would disrupt economic and political stability across Europe and Brexit would encourage isolationists elsewhere, to the detriment of world trade and prosperity.

Despite the latest polls, we still expect “Remain” to prevail in this week’s vote. One reason is that betting websites are continuing to indicate “Remain” is more likely to win than “Leave”; these markets have demonstrated a better forecasting record than opinion polls in recent elections. Another reason reflects studies undertaken by the research firm, YouGov. They have analysed previous UK referendums and found that enough people change their minds at the last minute to make polls misleading. They discovered that many voters respond to the emotional appeal of a radical choice during a campaign, but fears of change lead them to support the status quo once in the polling booth. YouGov believe the Scottish referendum in 2014 saw such a pattern, with many only deciding to support the Union on voting day. In addition, surveys continue to show more people believe “Remain” will be better for the UK economy and jobs than “Leave”, so we currently expect an increase in the “Remain” score as Thursday approaches.

Markets began responding to the changing message from the opinion polls in early June 2016, and currencies, shares and bonds are now probably trading between the levels appropriate for the two potential outcomes of the vote. This means we are likely to see sharp price moves once markets open on Friday 24 June 2016. If the UK chooses to stay in the EU, sterling and company shares will most likely rebound, and safe haven assets like index-linked gilts and other government bonds are likely to give back some of their recent gains. If the UK votes for Brexit, we would expect an opposite move in prices.

There are various reasons why a “Leave” victory is likely to lead to a decline in the pound and share prices. UK economic growth is likely to slow further as businesses and consumers delay decisions while they assess the ramifications of Brexit; this would reduce the attractions of UK assets in the short term. Secondly, markets may be concerned other countries will seek to leave the EU, and fears for the future of the single market could depress share prices across the continent. Additionally, many businesses in the City of London would be adversely impacted by Brexit, and this, together with a lack of clarity over the procedures and timescale of negotiations with the EU, would affect sentiment.

In the longer term, we are not overly concerned about the impact of a Brexit on UK asset prices. First, the Bank of England has scope to support the economy with further interest rate cuts and/or quantitative easing, given subdued inflation. Secondly, lower sterling should support the export sector and offset higher potential trade tariffs; it would also boost the value of profits earned abroad by UK listed companies. Thirdly, the UK economy is flexible and adaptable and will retain many natural advantages within Europe.

Whichever way the vote goes, there are likely to be interesting political consequences. Conservative MPs who are in favour of Brexit are in the minority within their party at Westminster, but a vote to stay could challenge Government unity. Meanwhile, a “Leave” victory is likely to lead to a change in Prime Minister, yet alone some vigorous debates in Parliament, where over 75% of MPs have declared they are in favour of “Remain”.

This uncertain short term outlook reinforces once again the merits of portfolio diversification; an appropriate balance of lower and higher risk assets and UK and overseas investments should enable portfolios to remain resilient in different market environments.

To discuss this note, or any other matter, please contact Nick Fletcher on 020 3696 6801, or any member of the London Wall Partners investment team on 020 3696 6805.



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