Equities  

Out would shake it all about

Out would shake it all about

The start of 2016 has been one of the most tumultuous periods in recent years for UK markets, with the FTSE 100 Index briefly entering bear market territory in the middle of January.

Fuelled by a collapse in the oil price and escalating concerns over China’s slowdown, the upcoming Brexit referendum on 23 June is giving investors yet something else to think about.

In my view, the worries over Brexit for the UK equity market – and small and mid-caps in particular – have been overstated. While I am keeping a close eye on the issue, and believe that some overstretched areas of the UK domestic market are at potential risk, overall I view any volatility in the lead up to the vote as an opportunity rather than a sell sign.

Article continues after advert

First things first, how likely is Brexit? Given how conservative and change-resistant recent electoral outcomes have been historically, I do not expect the UK to vote for Brexit. Fear of uncertainty is hardwired into human psychology, and levels of uncertainty around the global economy – and the UK’s place in it – are already heightened, irrespective of Brexit concerns.

That said, for as long as Brexit remains a possibility, I would expect to see some volatility in certain areas of the UK market in the lead up to the vote. The Scottish referendum in 2014 and the UK General Election last year showed us that even the prospect of political upheaval can have an impact on stock prices. In my view, certain domestic cyclicals are most at risk, particularly those sitting on elevated valuations.

If the Leave campaign is victorious, a worrying feature of the UK economy would likely come into greater focus: the UK’s current account deficit. It is the largest ever outside wartime, and is heavily financed by external investment. Foreign investment has gone a long way in plugging the deficit, but if we leave the EU there is no doubt it will be less appealing to do business with the UK. New trade agreements will have to be drawn up with not only European countries but also the likes of the US and Japan, which could take many months, if not years.

Speaking to the chief executives of companies I meet on a regular basis, some are postponing expansion plans until clarity is achieved. We can expect this to happen far more frequently if Brexit does happen, which could have a big knock-on effect while these trade agreements are redrafted. Recent studies show that a key reason for foreign direct investment (FDI) into the UK is because it is seen as a bridgehead into the EU. Brexit could endanger this as a motivation for FDI into the UK, and thereby risk financial outflows by international investors in the UK. Sterling will have to weaken considerably in order to boost export revenues, helping to fill the void left by exiting foreign investment@Image-a6c92e3f-5091-48a9-81c7-0cc9caa697a3@.