So, on Thursday June 23 we’ll decide if Britain should remain part of the European Union, or if instead we should exit the EU – the so-called “Brexit” we’ll hear uttered in every other sentence over the next few months.
Exciting! I bet you’ve already booked the following Friday off work and started planning an all-night Brexit buffet with your friends?
No? Just me watching Dimbleby until dawn?
Fair enough – I’m easily excited.
Still, even if you’re dreading four months of wall-to-wall European Union talk and resent the vote for disrupting Euro 2016, nobody could deny the referendum will be a huge moment in UK politics.
But for the UK stock market?
Not made in Britain
What we must always remember about our stock market is it’s an incredibly cosmopolitan collection of companies.
If the FTSE 100 were a voter, it’d be your most Europhilic friend who’s also forever backpacking around Africa and Latin America while wishing for a unified Star Trek-style world government.
Now, some FTSE 100 bosses might personally want us to leave the EU.
There may even be a few big companies that believe an ‘Out’ vote would be good for business, although I think you’ll struggle to identify them.
But in aggregate, FTSE 100 companies make about 70 per cent of their money abroad.
That means the state of the global economy is much more important to them than almost anything that happens at home – including a vote to Brexit.
Pound land bargains
What’s more, we’ve known the EU Referendum was coming since early 2013. Thus, Brexit uncertainty is almost certainly already reflected in market prices.
True, that’s not to say there couldn’t be an upset.
Personally, I think the market believes a vote to leave Europe is pretty unlikely, so if that changes then we could see a response from investors.
But ironically, when it comes to the largest UK companies, a greater perceived likelihood of Brexit could actually push the market higher.
That’s because concern will probably show up most markedly in the foreign exchanges, as we saw when London mayor Boris Johnson sided with the leavers and the pound immediately slumped against the dollar.
When the pound weakens against other currencies, the earnings and dividends of UK-listed companies with significant overseas income rises, all else being equal.
Some 40 per cent of UK dividends are declared in US dollars, for example. For investors in line for those dividends, a weaker pound is like getting a pay rise.
Would overseas buyers strike – or go on strike?
With most of the FTSE’s earnings generated overseas and any further weakening of the pound only likely to boost those earnings, I don’t see a great reason to panic if you’re a long-term UK investor.
But a few caveats…
Firstly, if you’re reading from Brussels or Baton Rouge; things are different.
That’s because if the pound weakens against your euros or dollars, you’ll lose money on your UK investments, potentially more than offsetting any gains you might see from share prices rising on an earnings boost from a weaker sterling.
But does this matter if you’re investing from Blackpool?
Perhaps a little bit.
The institutional money that dominates the ownership of the UK’s largest companies is global, and fund managers may decide to invest elsewhere until after the vote – or even sell down some UK shares – just to play safe. If that happens we could see the UK market weaken relative to other global peers, though personally I’d see that as a buying opportunity.
Also, I keep stressing that more than 70 per cent of the FTSE’s earnings comes from overseas, but a good chunk of that is generated in Europe.
Our European trading partners might be almost as disrupted as we are by any ‘Out’ vote.
Or they might not. Nobody knows, which is the fear with these events.
Beware of bricks and mortar
Of course, even if around 70 per cent of UK-listed companies’ earnings are generated abroad, that still leaves 30 per cent directly exposed to the UK economy.
So who is in the firing line?
Well, a handful of our biggest companies are much more UK-centric than most of their FTSE 100 brethren – Lloyds Banking Group, for example, or BT Group.
But it’s as you go down the size scale that you’ll generally encounter more companies that make their living predominantly in Britain.
Such mid-caps (think FTSE 250 versus FTSE 100) have had a great run for years compared to their larger peers, and their valuation already looks to me more vulnerable. Brexit might reverse that previous outperformance.
For instance, housebuilders and commercial property might be sectors to be wary of, at least in the short term, if you’re convinced we’ll vote to leave the EU.
Real estate could face a double whammy in an ‘Out’ vote because if there was a run on the pound and inflation looked like taking off, the Bank of England could decide to raise interest rates.
At the same time, foreign investment might be put on hold (what globe-trotting tycoon wants a luxury tower block in Battersea when the pound is plummeting?).
And all the palaver could paralyse British investors and stop them filling the gap.
Not a pretty scenario.
In, out, shake it all about
To my mind, such downbeat “What if…?” scenarios only apply to a minority of UK stocks, anyway.
I believe massive companies such as Royal Dutch Shell, HSBC and GlaxoSmithKline would all take an ‘Out’ vote in their stride, although I’m sure most would prefer an ‘In’ vote and an easy life.
The bottom line is while we’ll have plenty of things to chew over for the next few months as we make our minds up how to vote, I don’t think the UK stock market should be one of them.
But if it turns out that investors think otherwise – well, I’m happy to swoop in and take their quality multinationals off them at a discount.
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