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Don’t Bet on Brexit

Despite the European Central Bank’s herculean efforts to shore up the region’s economy, most of the major European bourses are down this year. The Euro Stoxx index, which tracks the performance of benchmark stocks in the Eurozone, has dropped nearly 4%  this year.

You can blame some of the decline on softening European growth – GDP is now forecast to grow by about 1.3% this year – but a bigger reason is the threatened exit of the U.K from the European Union, nicknamed the Brexit.

A sizable block of British voters has been skeptical of their country’s European Union membership from the beginning. They’ve argued that their economy is more competitive and has a sounder currency—the U.K. already doesn’t use the euro. Now many of those critics want out of the EU all together, with a referendum scheduled for June 23 to decide that question.

While British stocks are generally performing well despite the debate, British multi-nationals are slowing investments. Recent surveys also show that both business and consumer confidence is the country is beginning to slip, as the list of possible unintended consequences of a Brexit grows.

The biggest risk for Britain is that it might find itself temporarily shut out of the E.U. market. Member states are already showing considerable disagreement over what access to provide Britain to their markets if voters do opt to leave the EU, which could be a serious problem since Britain is running a current account deficit. If there’s a disruption to commerce or the country suddenly can’t tap European financing as easily, serious problems for the British economy could ensue.

The British pound has already been falling because of those worries and some of the economic forecasts based on a Brexit have gotten dire. A recent survey of think tanks on the economic impact of a Brexit just on Britain shows that most expect it would do serious harm, shaving anywhere from 2% to 5.5% off GDP growth in Britain alone.

Domino Effect

Perhaps the most dangerous unintended consequence would be more countries wanting to leave the EU. British voters aren’t the only ones unhappy with at least some aspects of the political and monetary union, so you can expect to see more referendums if the Brits do pull out. If just a couple dominos fall you can say goodbye to the euro currency and hello to the chaos that would create.

But don’t worry too much about a Brexit. We’re not. Brexit fears aren’t affecting our Global Income Edge European holdings. 

Most economists and high-profile investors don’t think it will happen. These are mostly the same people who predicted that Scotland wouldn’t secede from the U.K., so their track record is decent..

Better yet, look at the odds European bookmakers are giving.

The trend has been the odds of Britain leaving are getting longer. You may scoff, but when it comes to events with major political economic consequences, the bookmakers are usually spot on.  They’ve correctly predicted the past two U.S. presidential elections, the Grexit and Scottish succession questions, and a host of other potential problems.

We can take some comfort in the fact that the odds of a Brexit seem pretty long for now, but definitely expect more volatility for European stocks in the month to come.

 


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