Not too long before we will know the long awaited result from the EU referendum in the UK. Given both the attention it has gotten from markets in recent weeks, the emotion it will trigger with many and the impact on the way the political landscape will be crafted over the coming months, it will probably have a substantial influence on investor behaviour and positioning, whatever the outcome will be.
Moreover, it will finally create the opportunity to start thinking, talking and writing about other things than Brexit risks. Look into the global growth backdrop, analyse the prospect of a strengthening of global earnings momentum and contemplate if capital preservation, searching for yield or jumping on return opportunities will become the next investment theme in global markets.
Although it will be inspiring to think a bit more about other stuff, it remains difficult to see an outcome where politics completely disappears from the investment horizon. Other parts of the European political puzzle will remain on the table, political risks in number of important EM countries will persist and an unusual US election cycle is not too far away either anymore.
Most importantly for now, however, is whether there will be sense of stability emerging on the day after the Brexit vote or not. The only scenario that will safeguard this is probably a convincing “Remain” outcome, with the share of supporters of EU membership at or above 55% of the total. In such a scenario the political consequences seem likely to remain contained to the UK political landscape where advocates of Brexit might find themselves in the opportunity to pursue new chapters in their careers. In terms of the UK government, its policies and its relationship with the rest of the EU it will be seen as a vote of confidence and strongly support a continuation of the current approach.
The stability that this creates will cause relief in investor, UK household and corporate confidence and should support risky assets as investors unwind some of their cautious positions. Also, it will probably brighten the UK growth outlook as the recent string of disappointing UK data releases seems likely to get a boost from an increased appetite of UK consumers to spend and UK firms to invest and hire again now that the cloud of uncertainty over the UK future has disappeared.
The latter might not fully happen if there is only a small win for the Remain camp. Even if the actual result is not disputed by the Brexit supporters, the likelihood of some kind of relatively quick re-emergence of the Brexit topic on the political scene might remain uncomfortably high in such a scenario. It will be difficult for the current UK government to declare a convincing victory and some political “compromises” towards the Brexit camp might perceived to be politically necessary by Prime Minister Cameron and friends. Still, it would still mean that an actual departure from the EU will not happen in the near future. Therefore, it will not be problematic enough for markets to respond very negatively to the result, but it might well prevent a relief rally in risky assets and might leave the loss in economic momentum in the UK economy unrepaired.
And then there is Brexit. Different from a Lehman/Grexit like financial crisis, but a sharply negative political shock with uncertain, slower-burning political contagion risks both within the UK (will it survive after the next Scottish independence referendum is announced?) and within the remainder of the EU (will voter support for other Exit-strategies rise in other countries?). The interplay of policy maker emergency responses and signs of commitment of political leadership in multiple European capitals to send signals of unity will be crucial for the degree to which the initial negative market impact will be cushioned. And even a very strong performance on these fronts will not prevent markets from re-pricing political risk in the region and driving risky assets down. Also, the feedback loops into the real economy from these political and market dynamics will be negative enough to anticipate a UK recession and negative impact on the Eurozone’s growth outlook.
At the same time, it will not automatically trigger a short-circuit in the global financial system or cause massive write-downs on bank balance sheets. This is an important reason not to automatically see this leading to a global recession. And if it does not (no guarantees here obviously), it could also well occur that after a period of sharp risk aversion – on the back of an already cautious and cash-rich investor community – interesting contrarian investment opportunities start to emerge. The notorious mood swings of Mr. Market might well get into extreme territory during the Brexit aftermath and once it starts to become clear that the global economy has actually not sank into a black hole an impressive rebound in risky assets could easily occur during the second half of the year.
On the day after we will know the result, but it might be that only then the hard work starts from an investment perspective. Adding risk, but when and how can be a consideration in multiple scenarios. Equally, staying put or moving more defensive can easily be imaged. Especially once it gradually starts to sink in that the Brexit vote was actually not the only force in the universe that is driving our future. Good luck with digesting it all and save travels to the next destination.
Valentijn van Nieuwenhuijzen head of Multi-Asset at NN Investment Partners