The referendum is pretty much a done deal now, although the outcome of the referendum is obviously unknown at this time. Generally, in my experience, there is a lot of hype when there is an upcoming referendum but when people go to vote, there is a bias towards the status quo (as seen in Scotland recently). So I would not consider the Conservative win as the expression of peoples' desire to leave the European Union (EU) - but rather the inability of the Labour party to offer much to the people in this election.
That being said, if the British were to decide to leave the EU, it might lead to a lot of volatility but things would likely settle down quickly. It would be more of an issue if the UK was a part of the EMU (common currency Eurozone) and the consequences would be more serious. As it stands in its current form, the British membership of the EU, if it were to be discontinued, we believe it wouldn’t matter all that much. Just some reduced trade for both sides and lack of labor mobility, neither being too serious.
Also, there is a clear mandate for the Scottish National Party (SNP) so a repeat of a Scottish referendum is also in the cards. That one could be more damaging if the Scots left because they are very closely tied to England (currency, North Sea royalties, location of the UK nuclear arsenal, etc.). So that something to watch out for, not the potential EU exit.
For the Conservative leadership, it would be hard to argue the opposite sides on two different referendums so it is unclear how this might play out.
As for the market, we believe the effects of this election will be neutral at best for a few reasons:
- The UK market is dominated by global companies. Of the top 20 stocks by market cap, only 3 (Lloyds, BT Group and National Grid) are domestic plays. The remaining (HSBC, BP, Shell, Glaxo, British American Tobacco, Vodafone, etc.) all get a (big) chunk of their revenues from exports. So the level of global growth is more important for them (and election does not impact that). The banks and grocers used to be the heavy domestic weights in the index in the past but the bank bailouts and the struggles of the grocers in recent years now make them less significant in the UK market.
- There is also the argument that the decisive mandate will lead to a stronger currency; so by investing in the UK market you can get the currency benefit (like in the U.S. over the last 12 months, for example). Again, we don’t believe that strengthening of the currency will be tolerated by the central bank, especially versus such a weak Euro. So the sterling strength is also likely to be short lived in an environment when other currencies are weak.
- Some investors tend to get overly excited around decisive election results (India, Indonesia in the last year) but it takes time to deliver and the markets begin to lose patience. Even the market reaction today is muted because despite their current strength, the UK market is under performing other major European markets such as France, Germany and Switzerland. This is despite the UK market not having delivered even half the performance of the Eurozone market this year.
Anyways, all this being said, we continue to have healthy exposure to the UK in our funds because we find value in some stocks there, election or no election.