As 23 June approaches, the UK’s referendum on European Union membership is taking centre stage in investors’ minds. Indeed daily newsflow on the topic, including ever more frequent opinion polls, has started to cause some of the volatility markets expected. With the economic arguments in favour of “Bremain” (the UK remaining in the EU) now well aired, the referendum could now turn on the actual turnout of UK voters and on the more emotional topics of migration, immigration and Brussels bureaucracy.
Half-time results: Bremain 1 (economics) – Brexit 0
The UK government and a host of leading lights from the world of economics have thoroughly warned the British electorate that there would be significant costs to a Brexit. These include uncertainty over existing and future trade agreements, impacts on current EU policies and even the possibility of disadvantageous terms post renegotiation. It thus seems clear that the Leave campaign has lost this facet of the debate.
Topics for the second half
Having lost the economic debate, the Brexiteers are trying to shift the focus onto more emotional topics like immigration, political accountability and bureaucracy.
There is no doubt that immigration in particular can be a more powerful anti-EU topic, especially with the some influential sections of the UK media conflating free movement of peoples within the EU with the Middle East’s refugee crisis. Immigration concerns are also linked to public perception about the security of UK borders and, by extension, susceptibility to terrorism. Last year’s atrocities in Paris and more recent events in Brussels inflamed these concerns and anything similar would almost certainly spark an emotive response.
In this regard, the failure of government policies to cap immigration and stem concerns about the number of people entering Britain has been a focus of those campaigning to leave.
Projected turnout
In 1975, 64% of the electorate voted to join the European Common Market. It seems optimistic to expect a higher rate of participation this time, though there was arguably less at stake in the minds of the UK electorate back then. Consequently, the referendum will be very sensitive to both the absolute numbers of voters who actually show up to vote on the day and the age groups of those participating. The fact that older members of the electorate are both more likely to vote and more likely to be voting “leave” may yet prove to be a decisive factor.
To give a sense of the turnout’s potential significance, a participation rate of 64% is expected to yield a 53% overall vote in favour of Bremain; while a turnout of just 60% could deliver a 51% vote in favour of Brexit! For some historical perspective, the Scottish referendum on independence saw 85% of the electorate take part, while only 35.6% did so in the last European Parliament elections in 2014, (in which the UK Independence Party did well). Interestingly, across the EU, the average turnout for the 2014 European elections was only 42.6%, showing the lack of electoral interest across the EU as a whole. Turnout was notably dismal in Poland at 23.8%, who in October elected the decisively Eurosceptic Law and Justice party as its government.
The polls and book-makers’ odds
While we are increasingly sceptical about the accuracy of polls globally, it is fair to say that they have shown a consistent preference for the UK to remain in the EU, albeit with a large portion of undecided voters. Given the negativity of both campaigns, though, it is unclear whether these “undecideds” will actually vote at all, making turnout sensitivities even more decisive. The polls therefore offer an interesting but not necessarily accurate guide as to the evenness between those who have made their decision. Book-makers too have been consistently forecasting a remain victory. Across the board, the odds suggest only a 20% to 25% chance of Brexit. On this assessment, the Bremain campaign should win comfortably.
Politics
Whether the UK votes to stay in or to leave the EU, it is now clear that the ruling Conservative Party will have been badly damaged by this event, which has opened up deep fissures within the party. So, even in the event of a Bremain result, there is the potential for a cloud of uncertainty to hang over the government as it seeks to heel internal wounds.
If the UK votes for Brexit the country will be in for a high degree of political turmoil. One of the more obvious domestic issues will be the re-ignition of debate over Scottish independence – assuming the polls are correct that the electorate in Scotland votes to remain in the EU.
Additionally, internal divisions within the Conservative Party mean that a Brexit may require both a new prime minister and chancellor, and possibly a new general election. At the same time however, the UK would sorely need a team of experienced politicians to negotiate what could only be an extremely complicated and protracted exit from the European Union. Such a combination would place significant strain and uncertainty on the UK’s economy and political machinery.
For the EU project itself, a vote either way will inevitably lead to debate about the mechanisms for a two-speed Europe and in particular how fast the euro zone moves towards a “United States of Europe”. Insight into the latter can be found in the Five Presidents’ Report published in 2015. However, a growing number of governments within the EU face an increasingly eurosceptic electorate, as is the case in France or Poland for example. As a result, politicians will have to recognize that they have thus far failed to build a consensus for “more Europe”, often doing so by ignoring domestic referendums. Such actions have only served to lessen, not strengthen Brussels’ legitimacy.
Investment thoughts
There is a clear consensus that UK assets would be hurt by a Brexit decision, and that June 24th would see a day of volatility and trading akin to that seen in 1992 when sterling left the Exchange Rate Mechanism.
A vote to leave the EU would see UK equities, UK bonds and sterling all fall. Perhaps counterintuitively, this might mean UK assets that are “on sale” a week after a Brexit decision would be attractive on a longer term basis! However, UK domestic companies and assets have already been a weak performer throughout 2016 and increasingly look to have priced in some Brexit risk. In turn, international companies would benefit from a weaker currency in due course, suggesting the underperformance of the FTSE 100 Index against the FTSE 250 Index may correct. However, a Bremain vote would likely see a relief rally in those domestic sectors.
Overall, we believe that a Brexit would be bad for Europe, undermining some of the Union’s economic and political progress. An attractive hedge is to anticipate a rise in euro asset volatilities, although not as high as those currently in sterling. While a weaker sterling might fuel inflation fears in the UK, any significant weakness in equity markets would have some negative effects on credit markets; the two are closely correlated despite the European Central Bank’s quantitative easing policies causing some spread widening.
Either way, with Spanish elections occurring the following weekend, and the US going to the polls in November, political events remain capable of imparting yet more market volatility throughout 2016.
About the Author
Neil Dwane is the Global Strategist for Allianz Global Investors and part of the Equity Investment Management Group. He coordinates and chairs AllianzGI’s Global Policy Committee, which formulates the Allianz Global Investors house view, as well as leads and directs the agenda setting for the biannual Investment Forums. Mr. Dwane still manages some European equity portfolios, and thought leadership articles written by him are published regularly.
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Important Information
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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