in or out? the brexit discussion...while gbp is likely to rally on a “remain” vote, the uk’s...
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For Professional/ Institutional Clients only – not for Retail use or distribution.
Stephanie Flanders, Chief Market Strategist, UK & EuropeJohn Bilton, Head of Global Multi-Asset Strategy
In or Out? The Brexit Discussion
2
The economics and politics of Brexit
The investment implications of the referendum
The “what happens next”?
Brexit – a guide to the debate
3
Relative growth in real GDP per capita% change year on year
Source: European Commission, J.P. Morgan Asset Management. Trend is polynomial regression with order of five. *Combined GDP per capita growth.Guide to the Markets - UK. Data as of 30 April 2016.
UK
eco
nom
y
-8
-6
-4
-2
0
2
4
'51 '56 '61 '66 '71 '76 '81 '86 '91 '96 '01 '06 '11
UK joined EU
Trend
UK minus the average of France, Germany, Italy*
9GTM – UK |Britain’s economic performance has improved since joining the EU
4
Difference in polls between remaining and leaving%, three-month moving average
Source: Essex Continuous Monitoring Survey, What UK Thinks, YouGov, J.P. Morgan Asset Management. Essex Continuous Monitoring Survey data: 2004 to January 2015, YouGov data: February 2015 to August 2015, average polls from YouGov, ICM, Survation and ComRes: September 2015 to February 2016. All UK polling data excludes those that answer ‘Unsure’ or ‘Don’t know’ in response to questionnaire. Guide to the Markets - UK. Data as of 30 April 2016.
UK
eco
nom
y Net support for remaining
Net support for leaving
9GTM – UK |But the polls are tight…
-25
-20
-15
-10
-5
0
5
10
15
'04 '05 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16
5
Trade weighted GBP
Source: J.P. Morgan Economic Research, J.P. Morgan Asset Management. Data as of 30 April 2016.
-8%
+21%
Sterling has borne the brunt of it so far
6
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
1 3 6 1 2 3 5 7 10 15 20
And short-term market interest rates
Yield to maturity of government bonds% yield
Source: FactSet, J.P. Morgan Asset Management. Guide to the Markets - UK. Data as of 30 April 2016.
GermanyJapan
UK
US
Months Years
13GTM – UK |
Glo
bal e
cono
my
7
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
'15 '16 '17 '18 '19 '20
UK GDP deviation from trend% change year on year
Source: J.P. Morgan Asset Management. Data as of 30 April 2016.
Assumed referendum date
UK votes to remain
UK votes to leave
UK votes to leave and Scotland votes to leave UK
Stylised consequences of ‘Brexit’: a hit to growth for UK and Europe
8
0
1
2
3
4
5
6
7
'01 '03 '05 '07 '09 '11 '13 '15 '17 '19
Bank of England interest rate and market forecast%
Source: Bloomberg, J.P. Morgan Asset Management. Data as of 30 April 2016.
Bank of England base rate
Market expectations todayMarket expectations 1 year agoMarket expectation 2 years ago
UK interest rates would probably be lower for longer
9
UK trade balance with the EUGBP billions
Source: Haver, J.P. Morgan Asset Management. **FDI is foreign direct investment as of 2013. Guide to the Markets - UK. Data as of 30 April 2016.
UK
eco
nom
y
-90
-60
-30
0
30
'99 '01 '03 '05 '07 '09 '11 '13
GoodsServices
FDI** in the UK (£bn)From EU 453From US 262Rest of world 260
9GTM – UK |“They get more out of the relationship than we do”
10
We do know: there will be a trade-off between market access and integration
Source: Bloomberg, J.P. Morgan Asset Management. Data as of 4 April 2016.
11
Summary of possible Brexit vote outcomes and their asset class implications
Three post-Brexit scenarios bear examination, each with a different asset market impact:
1. Clear* vote to remain – relief rally in GBP, UK stocks outperform Gilts, domestic UK sectors supported
2. Marginal* vote to remain – relief rally short-lived, UK risk premia remain high, European assets also hit
3. A vote for exit – sharp sell-off in GBP, UK stocks weak vs. Gilts, financials underperform
Pound Sterling is likely to react first to the outcome of the vote and may be volatile in the run-up
UK gilt yields are sensitive to both the domestic economic outlook and to the appetite of overseas buyers
FTSE will initially react in the same direction as sterling, but longer-term if the pound falls earnings get a boost
Sectors: Financials are most sensitive to Brexit risk, while resources and energy may well be more immune
Source: J.P. Morgan Asset Management Multi-Asset Solutions; assessment made based on data available up to 9 May 2016.* Note: Clear "Remain" Vote (55%+ overall, and “remain” majority in all home nations); Marginal "Remain" Vote (<52%, and/or different outcomes across home nations)
12
Pound Sterling: becoming more sensitive to politics in recent years
Source: J.P. Morgan Asset Management, Bloomberg, Data are as of 6 May 2016. Note: Election periods are the 4 weeks prior to and 2 weeks after polling date; time series represents rolling 3yr Z-score of weekly change in GBPUSD implied volatility, adjusted for upside moves only, filtered for moves > 2 standard deviations, and further filtered for episodes when volatility moves are unique to GBPUSD, and not mirrored in EURUSD or USDJPY
Major spikes in volatility in pound sterling are associated with financial crises and, increasingly, with political event risk
Recent elections show that the volatility of pound sterling in the options market rises in the 4-6 weeks immediately before polling day
In an “out” vote, the currency would likely suffer first and fastest but downside risks would remain for some time after the vote
While GBP is likely to rally on a “remain” vote, the UK’s twin deficits likely cap upside for the currency over the medium term
0
2
4
6
8
Z-sc
ore
Election
Normalised 5d change in 1mand 3m GBP implied vol
2005 General Election
2010 Gen Election
2011 AV referendum
2014 Scottish referendum
2015 Gen Election
Brexit Vote
13
UK Gilts: caught between domestic economic risks and nervous overseas holders
Source: Bloomberg, J.P. Morgan Asset Management Multi-Asset Solutions; data as of 15 April 2016.
Monthly flows into UK gilts, signs of non-domestic selling Overseas buyers now hold around 25% of UK Gilts
-30-25-20-15-10-505
101520
Banks and Bld soc Private sector Foreign flows gilts
Central bank flows Net issuance
-50
0
50
100
150
200
250
300
350
400
Jan-
08M
ay-0
8S
ep-0
8Ja
n-09
May
-09
Sep
-09
Jan-
10M
ay-1
0S
ep-1
0Ja
n-11
May
-11
Sep
-11
Jan-
12M
ay-1
2S
ep-1
2Ja
n-13
May
-13
Sep
-13
Jan-
14M
ay-1
4S
ep-1
4Ja
n-15
May
-15
Sep
-15
Jan-
16
Cum
ulat
ive
flow
sin
ce J
an-0
8Central bank Foreign Pen/Ins Banks
To fund the deficit, the UK is increasingly reliant on non-domestic buyers of Gilts
In the event of an exit vote economic risks are likely to lead to “risk-off” trading, favouring bonds over stocks…
However, overseas appetite for Gilts may well suffer, especially if a falling pound causes a wave of derisking
Source: Credit Suisse, Bloomberg, J.P. Morgan Asset Management Multi-Asset Solutions; data as of 15 April 2016.
14
UK Stocks: Brexit would be a negative, but domestic sectors especially vulnerable
UK stocks would likely react negatively to Brexit; over time sectors with more overseas sales are likely to benefit from a weaker pound
Overall the equity market is likely to rally on a remain vote and sink on an exit vote
In the event of either a marginal vote to remain or an “out” vote, UK large caps (FTSE-100) are likely to outperform mid caps (FTSE-250)
There is wide variation in international exposure across UK sectors; in the long run the path of GBP is a key driver of relative performance
5%5%7%7%7%12%15%18%33%39%40%41%43%45%51%53%54%57%62%69%
93%98%
0%
20%
40%
60%
80%
100%
% o
f sec
tor s
ales
by
geog
raph
y
RoW
Asia
North America
Europe ex UK
UK
More domestic Less domestic
Source: Credit Suisse, J.P. Morgan Asset Management, Bloomberg, Data are as of 6 May 2016.
15
Eurozone assets: its not just in the UK that the EU faces popular discontent…
Recent poll data for an EU referendum around Europe Correlation of GBP and EUR adjusted* trade weighted indices
Source: Ipsos Mori, J.P. Morgan Asset Management, Data as of 9 May 2016Note: Adults aged 16-64 polled in March-April 2016
Populism and anti-EU sentiment are not confined to the UK according to recent polling data across other EU countries by Ipsos Mori
A marginal vote to remain could prompt calls for polls in other countries, or a second referendum in the UK
Contagion is possible from UK to European assets as these markets correlate most closely during periods of heightened uncertainty
-1.0-0.8-0.6-0.4-0.20.00.20.40.60.81.0
80
85
90
95
100
105
110
115
120
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16Equity market weaknessGBP TWI (ex-EUR)EUR TWI (ex-GBP)Rolling 2y annual return correlation (RHS)
0%
10%
20%
30%
40%
50%
60%
Italy France Sweden Belgium Poland Germany Spain Hungary
Think their own country should hold a referendumWould vote 'out' if a referendum was held now
Source: Bank of England, Eurostat, J.P. Morgan Asset Management, Data as of 9 May 2016* Note: adjusted to remove GBP from EUR TWI, and EUR from GBP TWI
16
Summary: Asset expectations in Brexit scenarios
Source: J.P. Morgan Asset Management Multi-Asset Solutions; assessment made based on data available up to 9 May 2016Note: Clear "Remain" Vote (55%+ overall, and “remain” majority in all home nations); Marginal "Remain" Vote (<52%, and/or different outcomes across home nations)
Asset Clear "Remain" Vote Marginal "Remain" Vote “Out” Vote
GBP (TWI) N/+ N/- - -
UK Gilts N/- + N
UK Yield Curve Modest steepening 5s30s bull flattens 10s underperforms 2s and 30s
FTSE-100 + N/- - -
FTSE-250 + - - -
UK Equity sectors Cyclicals > Defensives; relief rally for domestic sectors Up in quality, avoid financials Energy & Basics > Banks & Retailers
UK Real Estate N/+ N/- -
EUR N/+ N/+ -
Eurostoxx + N - -
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