By Mustafa Sagun, Chief Investment Officer, Principal Global Equities
At last year's General Election, Conservative Prime Minister David Cameron promised an in/out referendum, in an attempt to win over supporters of the United Kingdom Independence Party. Of course, while the Brexit/Bremain portmanteaus' provide the better soundbite, the referendum is for whether the United Kingdom (UK) will exit, or remain a part of, the European Union (EU).
Recall that the UK consists of England, Northern Ireland, Wales and Scotland. The Scots had a referendum on the remaining part of the EU, and are generally very pro-European, so in the event of Brexit, they would call another referendum, and look to rejoin Europe. We believe markets are being overly fearful of Brexit. UK stocks and the British pound are already reflecting a high probability of risk, which we see as opportunities for stock picking.
Perhaps reflecting the world we live in, even as campaigning has yet to fully commence, some pundits and commentators already seem to be calling it. Not unlike most votes, the undecideds, approximately 15-20% of voters at the moment, will be the deciding factor. The main argument for an exit primarily revolves around a desire to restore sovereignty and to escape the mess across broader Europe.
Negative press on many geopolitical fronts, including the Eurozone crisis, the Paris terrorist massacre, and the New Year's Eve attacks in Cologne, amongst others, have resulted in polls moving in favor of an exit. The UK knows they hold a distinct power benefiting from one of the most open markets in Europe, one of the most flexible workforces, and a language spoken all over the world.
As such, the EU needs the UK, perhaps even more than the UK needs the EU. Prime Minister Cameron's dealings with China, India, and others show that the UK has other markets that will trade with them. Without the UK, does the EU become increasingly irrelevant, or at least parochial? Juliet Cohn, one of our portfolio managers based in London, and a native Brit, provides a "boots on the ground" perspective in this insights piece where she expands on what Brexit or Bremain could mean for Britain and the UK, for the EU, and for equity markets as a whole.
As stock pickers, we look at these as times of opportunity. In our opinion, markets are being overly fearful of Brexit. An exit, no doubt, would have significant ramifications on the UK, as well as cause much upheaval across the rest of the EU. An already weakened pound further dropped relative to the dollar to a point that has not been seen since early 2009; although weakening against the euro likely helped the UK market be the best performing market in Europe year to date.
Consider that many UK-listed companies derive a considerable amount of revenues and profits from outside Europe with many having a truly global footprint. For example, Glaxo (NYSE:GSK), a large pharmaceutical company, generated over 70% of their revenues not just outside the UK, but outside Europe. The largest listed company in the UK, Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B), has less than 7% of their employees in the UK.
Our bottom-up focus on identifying fundamental change and sustainable earnings trends and exploiting the expectation gaps between our expectations and market consensus remains a constant. It may be a trying time in the UK and it is either an exit or not. Let's not forget what happened in Scotland with their referendum last year though. For a time, it certainly appeared there was going to be movement away from the status quo. Inevitably, there was not. On June 24th, it will be official in the UK. Brexit or Bremain? The clock is ticking.