A UK exit from the EU in the wake of the 23 June referendum would cause huge disruption for investors, experts say, with one leading economist warning of a “self-induced financial crisis”.
The announcement, which came a week after the FTSE 100, the UK blue chip index, fell to its lowest level in three years, prompted warnings of sharp market sell-offs as decision day approaches.
“Uncertainty is arguably the thing markets hate the most,” said David Thomson, chief investment officer at Glasgow-based VWM Wealth Management. “This will cause investors and companies to put their investment plans on hold, with many, including ourselves, reducing their UK exposure.”
The first response to the announcement was seen in currency markets, where Sterling hit a nine-year low. It may well fall even further, said Thomson.
“This will benefit exporters and simultaneously create a headwind for importers, so we are likely to see some short- term repositioning of portfolios possibly out of domestic companies and into the multinationals.”
While there remains a narrow consensus that the UK would vote to remain in the EU, the prospect of a close vote has concentrated minds on what would happen if it decides to leave.
“If polls are showing a clear out vote I would anticipate weakness at that point whilst investors work out the exact implications,” said Simon Lloyd, chief investment officer at Murray Asset Management in Edinburgh. “If there is no clarity I think we will get more volatility as the date approaches as the market dislikes uncertainty and will start reacting to daily prognostications from the pollsters.”
An exit vote would cause a “self-induced financial crisis”, according to Adam Posen, president of the Peterson Institute for International Economics and a former member of the Bank of England monetary policy committee.
“At a minimum you would expect this to induce a lot of uncertainty and financial volatility ahead of the Brexit. And if it occurred, you’d probably see very high interest rates, a fall in the currency, a lot of inflation, and a recession,” he said.
“And whatever you think the benefits of a Brexit are going to be, the costs of that recession are going to way outweigh them.”
The possibility of such negative consequences explains why a number of UK-based multinational companies have expressed concerns over the referendum, said Lloyd. “In particular, the apparent lack of willingness on the part of the US to countenance a separate trade agreement with the UK is an unwelcome development for the many UK companies selling goods on the other side of the Atlantic,” he said.
The timing of the referendum is particularly unhelpful, Lloyd added, not only for stock markets but also for the European economic recovery.
Thomson agreed, pointing to the two years of trade agreement negotiations that would follow a vote to leave.
“As most UK investors hold the bulk in their domestic market there could be a big knock-on negative impact on pensions and other investments,” he said.
So how will investors be affected, and how should they respond? An EU exit would hit certain investment sectors particularly hard. Financial services is the most obvious example, with firms likely to lose their ability to “passport” into other countries in the EU.
“This could weaken the whole industry and put further pressure on pensions,” said Thomson. “Manufacturing might also suffer the same type of headwind, while foreign investment into the UK would fall as we would no longer be an English-speaking gateway to Europe.”
The key for pension investors especially is to maintain a long-term perspective and minimise risk by ensuring their portfolios are diversified across different asset classes. These days that involves having global exposure and not just investing in UK firms.
“In the UK I would currently be wary of importers (such as motor distributors), retailers who source from abroad, travel firms and airlines and – if Brexit looks increasingly likely – the larger fund management groups and insurers,” Thomson said.
Lloyd is less concerned, pointing out that the underlying drivers of stock market performance tend to be more global than local.
“During the months leading up the referendum, the immediate impact is likely to be in currency rather than longer term trading factors,” he said. “I would suspect the market would be relatively sanguine if the polls are showing a likely vote to remain.”
The referendum was announced at a time when investors in Scotland’s capital are increasingly cautious. Just 16 per cent of Edinburgh-based respondents to a survey on behalf of brokers Willis Owen said they would take “either reasonable or substantial financial risk” to get a decent return, down from 21 per cent a year ago.