Ad Feature: In or out of the EU could have profound impact

Jon Dunn Chartered FCSI
Senior Investment Director
 
Investec Wealth & Investment Limited
Jon Dunn Chartered FCSI Senior Investment Director Investec Wealth & Investment Limited
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The EU referendum has been one of the dominant influences on investor sentiment in recent months, writes Jon Dunn, chartered FCSI senior investment director at Investec Wealth & Investment Limited, of Beech House, Sheffield.

The result could have a profound impact on financial markets if the leave camp prevails.

Investors have grown more jittery as the date of the in or out vote has approached.

The uncertainty surrounding the outcome of the referendum has been played out most visibly in the currency markets, with sterling having weakened on the foreign exchanges in recent months.

Some commentators have suggested that a vote to leave the European Union could lead to the pound tumbling by a further 10 to 15 per cent over concerns that capital and investment flows into the UK could subsequently slow significantly, putting the currency under pressure.

Having said this, a vote to remain could still mean a continuation of sterling weakness, albeit over a more prolonged period, due to the nation’s yawning trade deficit.

In times of uncertainty many investors seek safe havens for their capital and this has been reflected in recent weeks by the strength seen in the prices of UK government securities.

Indeed, the yields on 10-year gilts, which move inversely to their prices, have recently hit all-time lows.

A vote to leave the European Union when the vote is taken tomorrow could lead to further falls in yields, despite the fact that a weak pound could stoke the country’s inflation, which would be negative for such securities.

This is because the Bank of England would most likely respond by loosening its monetary policy, which would bolster the prices of gilts.

If the remain vote prevailed, government stocks would still be likely to stay in demand, as international investors would be attracted by the positive returns available on gilts at a time when many sovereign bonds, such as those in Japan and Europe, are yielding negative returns.

In equity markets, blue chip stocks in the UK have outperformed against those mid-cap securities during the year to date.

This has reflected the fact that about three quarters of the revenues and earnings of the largest UK companies are derived from overseas, while many smaller companies tend to be more exposed to domestic markets and so would be more adversely affected by a vote to leave the European Union.

Generally speaking, such an outcome would most likely lead to a sharp correction in the UK equity market.

Other global equity markets would be likely to be hit to some extent too, particularly in Europe given the perceived threat of other nations seeking to break away from the European Union.

A vote to remain would no doubt provide a short-term relief rally for equities, although many other challenges remain to be faced in the coming months, not least overcoming doubts about the health of the Chinese economy.

There are also doubts about the path of the Federal Reserve’s interest rate policy and the US presidential election campaign.

In or out, investors across a range of financial markets are bracing themselves for heightened volatility in the months ahead.