UBS: “Should I stay or should I go?” – the Brexit debate

1. Has the likelihood of a Brexit risen?

In our view, no. We still assign it a 30% probability, though we remain watchful as public opinion will likely shift during the campaign. Our base case is for the UK to stay in the EU. At this stage, the opinion polls still show more UK voters wishing to remain than leave. And just under one-fifth of the voting population has yet to pick a side of the battle. These “don’t know” voters could swing the results day, and are likely to choose the status quo, in our view. We expect UK economic momentum to slow ahead of the referendum (as uncertainty weighs on confidence) but rebound once the votes are counted.

In an alternate scenario, a UK economic recession before year’s end may follow from postponed business investment and hiring, and more cautious consumers. Uncertainty about trade channels across the channel could dampen external demand too – the EU, by far Britain’s largest trading partner, is the end destination for 44% of UK exports. And longer term, we think that potential growth would suffer.

2. What are the portfolio implications of “staying” or “going”?

Volatility: In our view, UK-linked assets may experience higher price turbulence over the next four months, as investors demand a premium for uncertainty. Sterling has already borne the brunt of such price swings.

Currencies: The pound has declined 4%–5% againstthe US dollar, euro and Swiss franc this year. Sterling exchange rates seem to have overshot interest rate differences, implying that a risk premium is already in the price.

Under our base case of a vote to remain, sterling should start to recover some lost ground after June 23. But additional downside is likely if the UK leaves. A further consideration is the reaction of the euro. Markets seem to have not yet priced in the potential consequences of the EU losing its second-largest economy, implying that downside risks to the euro could increase if the UK opts to leave.

Equities: We recently moved to a neutral UK stock stance in our global tactical asset allocation, funded by reducing the size of our Eurozone equities overweight position. UK earnings revisions are improving relative to European and global stocks, and a cheaper pound means that foreign exchange is no longer hindering internationally exposed UK large cap stocks.

In the event of a Brexit, the domestically biased FTSE 250 Index (which generates 49% of its sales at home) could underperform if domestic activity suffers. Given the possibility that European end demand may suffer too, investors might look to avoid Brexit risk by investing in UK equities that rely most on US sales orgenerate the lion’s share of their revenues in US dollars.

Authors: Dean Turner and Matthew Carter, Global Investment Office

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