If Britain votes to stay in the European Union, come the result on June 24th, it will be back to business as usual for both the economy and the stock market. But what happens if the electorate votes to leave the EU?
Ed Smith, asset allocation strategist for Rathbones says that the FTSE 100 as a whole will not be hugely effected – but certain stocks will be in for a shock share price drop.
“Long gone are the days when the FTSE 100 represented the UK economy. It is a global index that happens to be located in the UK – 70% of its revenues comes from overseas. Asia economic indicators are the best measure of mapping expected earnings in the FTSE,” he said.
“However, there have been some UK focussed stocks that have recently underperformed the rest of the market.”
Smith says this is largely due to oil and gas and mining stocks rallying so significantly in recent months, rather that Brexit fears penalising certain parts of the market – but concedes it is these domestically focussed companies that are most at risk should we leave the EU.
“UK banks are the most at risk if we vote to leave,” he said. “Not Standard Chartered or HSBC which are international but the UK retail banks. Regulation is to blame; those we have talked to unanimously agree that the direction of travel within the financial sector is it will be increasingly difficult to do business in Europe if you are not part of it.”
Smith stressed that he did not expect the entire sector to collapse, but recognised that there would be added costs of doing business which would put a strain on banks.
Small and Mid-sized Stocks at Risk
As smaller companies tend to be more domestically focussed, Brexit uncertainty has led to share prices falling this year. Currently medium and small sized companies are priced for economic disaster rather than on company fundamentals. With Brexit risk already priced in this could be a buying opportunity for investors who believe the UK will not leave the EU.
If we do leave the EU, Smith highlights sectors which trade with the region as most at risk for a share price drop – auto manufacturers and clothing may be subject to big tariffs to do business in the EU, although not enough to derail the sectors entirely.
Will We Plunge into Recession?
The International Monetary Fund earlier this month warned that the impact of Brexit on economic growth could result in a downturn of between 1.5% and an incredible 9.5% over the next decade. Over the weekend, the Treasury added its own predictions of potential impact to the remain argument, saying that the economy would slow between 3.6% and 6% over the next two years if we voted to leave the EU.
Smith said that he thought even the base case was overstating the risks, but that getting an exact handle on the data is difficult. He called to mind the event in 1992 when the government has suspended Britain's membership of the European Exchange Rate Mechanism. This resulted in an economic contraction of between 1 and 2%.
It is worth noting that the chancellor at the time Norman Lamont shortly afterwards reduced interest rates to 12% from 15% - leverage not as easily available to the current government.
“GDP will take a short term hit in the event we leave the EU – although it is more difficult to call over the long term,” said Smith. “Investors should be cognisant of those sectors which are most correlated with GDP; insurers, banks and household goods.”
