Our Opinion: 2016

Two days to go : UK decides on its European future

Investment markets are see-sawing in the final stretches of the EU referendum campaign, but investors will be wondering whether there will be any respite once the voting is over.

Will things be any easier from 24th June?

Regardless of the outcome of the UK referendum, the prognosis seems best for bonds. Even though yields on UK government debt are paltry, they’re better than those in parts of Europe (German 10-year debt went into negative territory for the first time this week) and Japan, meaning investors who are virtually compelled to purchase such assets – pension schemes for instance – will see UK government debt as relatively attractive.

JLT Employee Benefits recently published some research showing FTSE 100 companies have a record 61% of their assets – £330bn – in bonds, compared to 50% in 2010.

Quite apart from the Brexit debate, the UK appears to be at the latter stages of its business cycle and assets look expensive given the economic backdrop. Large-cap equities could benefit if the UK left the EU because sterling would likely weaken,which would be positive when overseas earnings were translated back into pounds. But, the consumer sector and small and mid cap stocks could be hit.

The only known factor is what will happen if the UK stays in. Not very much, because we are already in the EU. So how much weight should we put behind the experts and their views about what would happen if the vote were to leave the EU?

The immediate mechanical effect would be a boost in public finances, but perhaps not by as much as people think. The UK contributes £350m a week to the EU, or £18.8bn a year, but it also receives back around £14.4bn, so the weekly contribution comes down to just £75m. Given that the UK spends more than £2.5bn every week on its National Heath Service, that doesn’t look like very much.

It is the uncertainty factor that is guaranteed to make markets uncomfortably volatile, not least because no one knows how the EU itself will react to a leave vote. The knock-on effects are dangerous for Brussels, because other member states could also use the UK no vote as a launching pad, either for fundamental reform or an opportunity to leave.

With days to go and the outcome of the referendum still uncertain, it is prudent for investors to remain focused on what the referendum result may mean for their portfolios – whatever the outcome.

They should focus on diversification and hedge against political unknowns. Investors should already have reduced excessive exposure to sterling assets, or considered capital protection against the risks. 
Most importantly, investors should remain alert to mis-pricings, be they in currency, fixed income or within equity markets. Extreme market movements come about from over-reaction to unfolding events and exaggerate underlying concerns.

The country and the markets will soon begin to adapt to the UK’s future outside the EU. Alternatively, it will be business as usual as economists analyse UK house price data and Public Sector Borrowing figures which are both out next week. Whatever the scenario, the UK economy will be much where it was before the campaign started – with the same strengths and weaknesses.

Most people in the UK want the same thing in their relationship with the rest of Europe. They want a fairly loose, flexible partnership with our like-minded neighbours in a radically reformed European Union. Unfortunately, that has turned out not to be achievable. The country disagrees on what is second-best and Thursday’s referendum is likely to be close.


Alexander Wade

21st June 2016