EU referendum: In case of Brexit investors should brace themselves for turbulence in equities - particularly if those stocks are affected by European trade

 
David von Dadelszen
Children Participate In The Annual White House Easter Egg Roll
It would be eggstremely silly not to diversify ahead of Brexit (Source: Getty)

Last weekend saw David Cameron return from Europe with details of his renegotiated deal for Britain’s membership of the EU.

While the date for the referendum (23 June) and the question which the populace will need to answer are now certainties, the implications of a Brexit are still extraordinarily unclear. Many individuals and commentators claim to know what these outcomes will be – however the reality is these are simply their best guesses.

Broadly, all UK equities are likely to experience a degree of turbulence. With the many macroeconomic risks currently looming around the global economy, this added uncertainty will put wind into bearish sails.

Many UK small caps are focused on the domestic market, and will consequently feel the impact of any short-term domestic slowdown more acutely than their larger counterparts.

While small and mid-caps will feel immediate turbulence, once the market has settled, they may well benefit from a reduction in the regulation which currently creates a level playing field for exporters, however carries no benefit for businesses that do not export.

Consequently, with this burden removed, these companies should increase their profit margins in the medium to long-term.

The performance of larger multinationals on the other hand, which tend to operate across more markets, will be determined by the destination of their exports. Those focused on exporting to the EU may well suffer strongly.

Those exporting to non-EU jurisdictions should be relatively unaffected by an exit. Indeed, the value of income generated overseas will be worth more back home with the concurrent weakness in sterling, and will be a plus for companies with international revenue exposure.

The challenges facing investors are however not so straightforward.

Brexit is not the sole source of market turbulence. Lacklustre growth is plaguing the global economy. India is performing relatively well, but beyond this, the situation in emerging markets is fairly ugly, and growth in developed markets continues to be unimpressive.

Against such a bleak backdrop, what should UK investors do?

The immediate reaction of many will be to turn to safe haven investments. In a turbulent market it is logical to invest in debt rather than equity, as debt holders are the first recoup their funds should the company get into difficulties. High yielding debt however performs closer to equity, and in line with this, we’re likely to see highly rated corporate debt and government bonds increase in value.

Investors in debt or equity would also do well to stick to defensive sectors, as they will hold their value relatively well in a turbulent market. Utilities, infrastructure and pharmaceuticals – services people always need – will be sought out.

Cyclical businesses such as house builders and material suppliers have the risk of experiencing extensive downswings.

The trend is already being played out the property sector. A number of hedge funds are taking short positions on FTSE 100 home builder, Berkeley Group, in anticipation of the share price falling further.

While speculative, their position takes into account several important factors, including the high number of luxury developments already on the market, and the impact of weakening emerging market currencies on foreign buyers.

As the referendum draws ever nearer it’s critical that investors interrogate a prospective investment, and look beyond its current performance to assess what its performance will be if an exit from the EU comes to fruition. Diversity is key to a successful investment portfolio, and this statement rings even more true now in the current, incredibly uncertain market.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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