On June 23, UK voters will decide whether to leave or remain in the EU. The run-up to this referendum has caused some concern in markets – most visible in the weakness of the pound sterling, and a pause in the pace of economic activity in the UK.
The impact on UK-listed stocks has been relatively muted, cushioned by the high proportion of non-UK earnings amongst larger UK companies.
So what happens when the votes are counted on the 24th?
The odds are against an exit
The most likely answer is very little. Opinion polls have predominantly shown a narrow majority of Britons in favour of remaining in the EU. Given that behavioural studies suggest that voters will shy away from uncertain decisions as the date approaches, this does not seem sufficient support to carry a vote to exit. Betting odds (which are usually more reliable!) suggest only an 18% chance that the UK will vote to leave the EU – and that likelihood has been falling over the last month. In this case, markets are likely to breathe a sigh of relief, sterling rebound a little and attention move rapidly on to other issues.
If it does happen, UK companies face uncertainty
Alternatively, if polls are proved wrong and the UK does vote to leave, this is when the uncertainty really begins. This will manifest itself in both the economic and political sphere. In terms of direct economics, the principal impacts of a Brexit decision would come via trade and investment flows on the UK. Outside of EU membership, the UK would have to rapidly renegotiate trade agreements globally. The uncertainty over these negotiations is likely to prompt further weakness in sterling and a more prolonged hit to UK economic prospects as investment falls further.
But the UK is small in terms of world GDP
Although this may be significant for many individual UK companies, at a global level, we should bear in mind that the UK economy is less than 4% of world GDP. A weaker outlook here is a negative, but the impact should not be a game changer.
An exit may trigger a risk-off attitude
The second (and potentially greater near-term) impact would come via the political fall-out. In the UK, it is unlikely David Cameron would survive a vote to leave, prompting a change of government or at least prime minister, and most probably calls for a further Scottish referendum. This turmoil would obviously complicate further the path of trade renegotiations. The political impacts would also extend more widely across Europe. The UK vote to leave would provide ammunition to anti-EU parties throughout the continent and markets might again revisit questions of a Eurozone break-up, potentially widening bond spreads for the periphery. The immediate reaction in markets is likely to be a sharp pull away from risk assets across Europe.
Will central banks save investors again?
The extent of markets’ reaction to a vote to leave is hard to predict, as it will depend on the response both of central banks (the ECB and Bank of England), and politicians. Market nerves are likely to eventually to be calmed by central bank support across bond markets, but investors should brace themselves for some increased volatility over the summer.
And if a Brexit doesn’t happen?
The greatest probability is simply that the risks of a Brexit will quietly disappear into the rear view mirror. However, this is unlikely to prompt an outbreak of investor euphoria. In a world characterised by low growth rates, political risks will keep bubbling to the surface. Coincidentally, Donald Trump is scheduled to visit the UK the day after the Brexit vote – the baton of political risk is ready to be handed on.
Colin McQueen is a Senior Portfolio Manager at Sanlam Four.