With just under a month to go, the Brexit debate is reaching fever pitch. Whatever the rights and wrongs of Brexit the market appears to be pricing in a “Bremain” for the time being with a 13 point lead over “Leave” in the opinion polls as of 24th May. According to current betting odds, “Remain” has a 79% chance of winning.
Sterling has recovered from its recent lows as the markets begin to price in greater likelihood of a “Remain” victory. However there is still plenty of time for the “Leave” campaign to recover lost ground as we approach the actual vote, especially with the number of undecided voters. While the eventual outcome is still unclear it is prudent to prepare for both eventualities.
So what would a Brexit mean for expat investors? Well in the short term a weaker sterling and weaker equities will hurt investors in the UK market. However, this would lead to a more competitive export position from weaker sterling and, should we see stability in commodities, then the relative valuation of UK equities will be attractive to investors. A Brexit, in our view, could spark consolidation and M&A in the UK, as more businesses seek to benefit from being based in UK, where a more flexible tax and labour market and lower valuations will attract businesses.
Over the last 6 months, we have seen a stabilisation in energy prices and volatility in both equity and currency markets, particularly at the start of the year, although this has abated over recent weeks. Government bond yields have remained low, in part due to the Fed stepping back from further rate rises after December’s hike. Sterling weakness, stable commodity prices and lower bond yields should all be positive factors for the UK economy, although we have yet to see a pick up in economic data, prompting the Bank of England to comment on the negative effect that the referendum is having on business sentiment.
Should the “Remain” campaign win Gilt yields may fall to reflect a risk reduction and a return to a “safe haven” status. Gilt yields are currently trading on par with Spanish and Italian bonds, and are 1.3% and 1% higher than German and French bonds respectively, and we expect these differentials to contract if the UK votes to remain in the EU.
Should the “Leave” campaign prevail, we expect Sterling to substantially weaken in the short term, and expect increased volatility in UK equity and Gilt markets. We don’t believe that the impact of a Brexit on European assets has been properly evaluated by the market, so we expect increased volatility here too. A subsequent flight to safety would see an increase in the Dollar and US assets, which we believe would put further pressure on Emerging Markets.
We are currently looking at the effect of increased currency volatility on funds with UK exposures. We are looking to balance portfolios by allocating to funds with increased large cap holdings as they are likely to generate more earnings in foreign currencies. This should help to hedge against a sharp fall in Sterling if the “Leave” vote wins the referendum on 23rd June. We are also positioned to take advantage of further US Dollar strength in a “flight to safety” environment.
Join us in the Brexit debate at the BritCham Breakfast Briefing on 14th June. Hear the key points of both arguments so you can make an informed decision to vote.
David Pugh, Director, The Fry Group (Singapore)