Market implications of a vote to Remain
If the Remain camp wins, it is rational to expect a relief rally in UK assets in the immediate aftermath of the vote as the uncertainty of Brexit is removed. Sterling, gilts and UK equities would all be expected to perform well. Within equities, it is our view that those parts of the market that have performed poorly so far this year will be the areas that will outperform.
Equally, mid-cap stocks and financials have underperformed the broader UK equity market for the year-to-date. Of the 40 industry groups within the FTSE All Share index the two worst performing for the year-to-date are Banks (-5.2%) and Life Insurers (-12.9%) compared to a return of -1.9% for the broad index itself.
Outperformance of the financial sector could lead the Bank of England to bring forward any decision to raise rates. The BoE has expressed caution about the potential impact of Brexit on the UK economy and this is one reason why rate hikes have been delayed. Removal of the Brexit threat taken together with the potential for inflation to rise into year-end as the influence of low oil prices wanes and the lagged impact of weaker sterling begins to take effect could be sufficient to see a rise in rate expectations and a catalyst for financial sector outperformance.
What if….?
If the UK votes to leave the EU there would begin a two-year process during which the terms of exit would be negotiated. This would bring with it an enormous amount of uncertainty though it seems likely to us that, at least in the immediate aftermath of the result, there would be a negative impact on sterling, UK equities and foreign direct investment as investors deferred investment decisions until the uncertainty subsided.
The uncertainty associated with a vote to leave could be magnified by the fact the EU negotiators will be incentivised to make the exit process as difficult as possible for the UK. Were the UK exit process perceived to be straightforward with relatively little cost, this would surely encourage other countries to go down the same route. It is possible that, in the event of a vote to leave, the euro would sell off in sympathy with sterling in response to this heightened threat.
A vote to leave would also create vulnerabilities for UK domestic politics. It would be difficult for David Cameron to remain Prime Minister and a Conservative Party leadership contest would soon follow, creating uncertainty both for the country and the Tories. Even if there is a vote to remain, Cameron’s leadership may well be challenged by disaffected colleagues, particularly if the vote is close.
One reason the Conservative Party felt obliged to call the referendum was because of a rising tide of political dissent within its own ranks with regard to EU membership, as well as the increase in popularity of the anti-European UK Independence Party, culminating in that party taking 12.7% of the vote in the 2015 General Election. A referendum could draw a line under that dissent, particularly if the result is decisive. However, if the Remain camp wins with only a relatively small majority, there will remain a large minority of disaffected voters. The referendum will therefore have succeeded merely in creating a significant amount of uncertainty without properly resolving the issue it was intended to address. The European issue was a contributory factor in the downfalls of the two previous Conservative Prime Ministers, John Major and Margaret Thatcher. David Cameron should be careful that it does not claim another scalp.
