Market Tactics Ahead of the Brexit Vote

The market now resembles one of those challenging Harold Pinter plays where the dialogue of the characters is mysteriously compelling but outwardly meaningless, because Pinter avoids putting it into a plotted or themed context. ‘What’s he on about?’ whispers one member of the audience, nudging the one next to him. ‘No idea!’ responds the ‘nudgee’! In that spirit of dramatic Pinteresque bemusement, I have been trying to work out where we are now in terms of the market plot.

Helpfully, we now know as a matter of authoritative fact (the last reported contents of a monthly survey of global fund managers by Bank of America Merrill Lynch – the latter bit once known as the ‘thundering herd’), that global investors are more underinvested in UK shares than at any time since the banking crisis in November 2008. Since the UK was and is the world’s leading global banking centre, that is a finding of some significance.

The probable implications arising from the finding include the following: first that the institutional shakers and movers have largely made much of their move. They will probably be primed to get back in and hopefully make a profit if the British man (and woman of course) decides not to Brexit. One supposes that if the vote is for freedom and the uncharted seas of national, trade bloc free, independence, then global investors are likely to wait and listen to the chorus of many voices of opinion on the subject. Uncertainty will still reign.

However, specifics will still apply to international UK shares; the price of oil for example, would be the deciding card for oil shares. In that regard, it’s interesting to note that whereas the FTSE100 Index has declined about 5 per cent in the last month, BP shares have fallen by half that amount. It is also interesting to note that British banks as a sector have done better than the FTSE 100 Index by falling only 3.3 per cent. Although HSBC has also fallen 5.4 per cent – the same as the FTSE100 Index – over a month, Barclays appears to be in positive territory, having risen 1.6%. It is of course a complex picture.

Looking around to get some rough idea of what has occurred, I note the following as guidance for wise men (and women of course!):

Over the last month and six month period the FTSE 100 index fell 5.3per cent and 4.0 per cent respectively. Bank shares on that basis fell 3.3 per cent over a month and 4.0% per cent six months; oil and gas shares were down 3.3 per cent but up 12.6 per cent over the six month period; property shares/REITS were up 1% on the month but down 10.5 per cent over the  six months; minerals and mining dropped 18 per cent in a month but were up 6.4per cent over six months; hotels, restaurants and leisure shares deteriorated 1.6 per cent last month but increased 4 per cent over the last six months; in the personal products sector, exemplified by Unilever, share values were down 8 per cent but up 8.7% on six months’ consideration. Finally, UK beverages, exemplified by Diageo, fell 3.8% over the month but scarcely budged in six months.

Passing a cursory eye over this data there are not many examples where the movements have been dramatic or panicky looking. Furthermore, it seems that Brexit considerations have been mixed and diluted by other perceptions of sector specific factors.

By way of example, that stands out noticeably in the case of oil and gas shares. In that sector, the increase in value over six months was a significant 12.6%, which no doubt reflects the change in sentiment towards oil as well as the actual increase in the price of a barrel of crude oil. But the 3.3 per cent decline in the last month, as well as being profit taking, also reflects concerns about the pound in which the shares are traded and quoted.

It is naturally impossible to draw any clear cut conclusions from such a complex set of correlating factors. However, the numbers above do suggest that if the global appetite for UK shares is so very low, then the impact of that, for whatever reason, has been significant but not monumental. That in turn suggests that although there is ammunition here for a bounce in the market if the Brexit option is rejected by referendum, it will be a usefully worthwhile one for those who are able and quick enough to get aboard, but once again, not a monumental one.

The other implication of the Brexit referendum situation is that it takes place just after the month of May – the month when markets have historically seasonally peaked in many years, but of course not in every one of them. (No stock market ‘rule’ is ever definitive.) So this year, in the event of a ‘no’ to Brexit we are likely to have a good rally in early summer before markets grow truly quieter and thinner in the following months of high summer. Such a rally, in my opinion, would be in part relief at the passing of unquantifiable uncertainty about what happens next in the UK both economically and politically; part technical (covering and index matching etc.) and finally, hopefully, confirming a satisfactory profit by closing or reversing the position.

If there is a Brexit ‘yes’ vote, then it will almost certainly be a year in which the passing of May would mark the traditional wisdom of having sold and gone away. It seems highly probable that such a result would take time to digest, not only because of the obvious new economic imponderables but also because of political change in the UK Conservative party and the government it provides. There will be a definite chill in the air if one prime minister goes and another arrives as a result of internal party politics. It will, I am sure, feel a bit like a death in the family without the truly democratic decision that normally precedes and occasions such changes in government. It will be more like an abdication than a coronation.

For those who want to speculate on the outcome of the referendum in the hope of making money out of it, I suggest it will be like a race between horses without known form. On the face of it, there will be the conservatism in many places that comes from a fear of change, competing with a kind of reckless fatalism to be found in other places. The latter, I suppose, to do with a current disenchantment with most existing political structures everywhere.

Will the young come out to vote a conservative ‘no’ to Brexit; and will the old come out to vote a radical ‘yes’ to leaving harbour for the uncertainties of a voyage across uncharted waters? If you rate yourself as a successful diviner of changing national psychology then here is your great challenge. The banks will no doubt be hiring surveys of opinion and the rest of us will check the bookie’s odds.

The banks, of course, will face a particularly and potentially challenging phase if the Brexit vote is for leaving. Currency realignments and changes in bond values will impact their highly geared balance sheets if assets and liabilities move too far apart. Thoughts of 2008 come back to mind. Then, the dislocation and mistrust was so widespread as to cause a liquidity crisis in which even outwardly good quality assets were not trusted for repo financing purposes – the process whereby banks short of liquidity borrow against assets to keep the banking system working.

The big difference between then and now is that now we are alert to the possibility of such problems, unlike 2008 when few saw it coming. At least we now know that the whole UK banking system is on ‘red alert’ and the Bank of England is ready to swiftly provide its lending of last resort, should that prove necessary. Moreover, the scale and quality of capital assets of US and UK banks are incomparably better than they were in 2008 when some banks had tons of off balance sheet liabilities of questionable value hidden in ‘conduits’, and some of the so called balance sheet capital was, frankly, not capital at all.

The more challenging conditions lie in Eurozone banks, which still seem to be generally behind the kind of capital reform undertaken in the UK, US and Switzerland. Should the Euro weaken along with the pound or perhaps even more than the pound that could prove a much bigger headache. For that, appropriate thanks oh Lord!