Armageddon Alert: Will “Brexit” create a black hole that swallows planet earth & the universe ?
Reading the press and comments of market pundits lately, one might get the impression that the end is near if the British referendum next week will result in a vote for leaving the EU.
Some examples (I spared myself the links)
- Pound may drop more than 10%
- Stocks could drop 30-40%
- Gold will shoot up by more than 10%
- 140 bn German exports in danger
- Which countries will be next to exit
- Uk house prices could fall by 18% after Brexit
- Brexit will cost Germany 3% GDP growth
Clearly, my own headline looks a little bit exaggerated compared to this but not that much.
My take on Brexit and potential impacts:
Analytically one could break down the “Brexit” case in different issues:
- Will UK voters vote for Brexit (yes/no)
- What will actually happen if the vote is for Brexit ?
- What is already reflected in market prices
Issue 1: Will UK voter vote for Brexit
This is the easiest one. The polls say something like 50/50 at the moment, however I do think that a lot of polls are biased to reflect the opinion of the party commissioning the poll.
Or one could look at the odds in the betting market and even “punt” on this. Looking at the quotes (and the market seems to be quite liquid these days with more than 20 offers) tells us that people who actually bet money on this pretty much believe that the answer of the Brits will be”Stay”.
Issue 2: What will happen if the Brits vote for Brexit
Interestingly, many commentators seem to know exactly what will happen and that the only possible outcome is the way to doom, both for the UK and the EU. My own (shallow) research however tells me that there is high uncertainty within the second part of the question.
As far as I know, the UK and the EU would start negotiations at some point in time after the vote with the clear goal on UK side to keep everything what is good (market access etc.) and get rid of all the bad things (payments, refugees etc.) The EU on the other side will want to make sure that the deal for the UK doesn’t become too good so that not suddenly everyone wants to leave. Plus, countries like Germany or France still want to trade with the UK.
The outcome in my opinion is not clear. The UK already has already a special status (own currency, doesn’t pay its full dues etc.) so there could be clearly a lot of scenarios where there might be some “headline” changes like UK citizens have to use the Non-EU passport control booths but otherwise everything stays the same.
One could even argue that a potential Brexit has an overall positive impact. Why ? Well, it is pretty obvious that the current state of the EU is not very functional. Politicians (and Eurocrats) all argue for closer ties in order to tackle the problem. But is this really the solution ? Maybe the EU has gone already to far ? Economically most important in my opinion is free trade. Do we really need to have the same currency and an ultra strong central power in Brussels ?
One could look for instance at the different European nations and compare their systems. France for instance is very centrally organized, Germany on the other hand has a much more distributed system with a lot of regional delegation of power. I would argue that the decentralized system can have a lot of advantages and is often more resilient to crisis than a strong centrally run system.
Of course there are also possible future paths which would lead to really bad outcomes. Maybe France and the UK start to fight for the channel Islands again ? Who knows. But I think the important point is that what we hear in the press are opinions and possibilities but not facts or certainties.
Issue 3: What is already reflected in market prices ?
As I have outlined above, it is close to impossible to quantify the impact of a potential Brexit as no one knows for sure what will actually happen. So there is a lot of uncertainty in the market. On a personal level, especially institutional investors don’t want to get caught with their hand in their pants like our national coach Jogi Löw in the match against Ukraine:
As an institutional investor, you will have a lot of personal downside if you are overweight UK or GBP assets and something terrible happens. Even if you are equal weight and markets go down, your bosses will yell at you why you were such an idiot. So the rational thing is to underweight before and show “risk management skills”. You look like a hero if something bad happens but you will not be punished when markets will actually go up.
So I guess it is pretty likely that some of the potential negative consequences are already priced in. Just for fun I currently ask almost everyone about the pound: What will happen the day after a Brexit with the Pound ? 99% of the people I asked say: The pound will fall. When you ask why, then they become unsure and say “because it has to fall”.
However it is clearly almost impossible to know how much has been priced in already. Is a full Brexit already priced in or are investors currently assuming that the Uk will stay ? Hard to say.
So to sum it up:
- we do not know how the referendum will turn out
- we do not know what the actual impact of a Brexit will be
- we do not know what is priced in into current market prices
So it is pretty useless to make any predictions on what markets will do after a Brexit knows. No one knows. Period. Yes there could be a further stock market correction or Gold could go up, but that might have happened anyway.
So what to do now as a (Value) Investor:
That is easy: Just do nothing and relax
I own 4 UK listed stocks (Admiral, Lloyd’s, Aggreko, Ashmore) and one stock with significant UK exposure (Handelsbanken), in total ~20% of my portfolio. Should I sell them or hedge the pound ? I don’t think so.
Will people stop insuring their cars the day after a Brexit vote ? Will people sell their Emerging Market funds ? Will UK banks go bankrupt on Friday because they were betting all their capital on staying in the EU ? Will every house owner default in the next 2 years ? I do not know but I don’t think that is likely. What I do know is that all those companies have good (or very good) management who will work very hard to manage this risk and many other risks which could negatively impact their business.
If you actually feel like selling a UK stock because of the potential Brexit, you should sell it anyway, no matter what happens because your conviction is maybe a little bit on the low side.
Should one buy UK companies when their prices fall next Friday ? In my opinion only when you really know the company and know that it is undervalued. A falling stock price alone doesn’t tell you if the stock is good value.
I have one stock on my watch list (Old Mutual) and when it hits my limit I will buy.
Other than that I actually consider to take next Friday off and not even watch the market, as funny as it might be.
I plan to do the same post in autumn, I will just replace “Brexit” with “Donald Trump US President” and replace my UK stocks with my US positions.