A share trader's guide to Brexit

Brexit looms as a major risk event for global markets. This post looks at what you need to know about the day of the vote and the potential implications for both global markets and the Australian share market.

Brexit Basics

On Thursday 23 June, Briton’s will vote on the following question

                Should the United Kingdom remain a member of the European Union or leave the European Union?

There will be no exit polls. Markets will need to wait for the official count to gauge how the vote is going. Counting will commence when polls close at 22:00 GMT (7am Friday 24 June AEST).  How long it takes to declare a result will depend on how close the vote is. Projections are that this may be possible around 4am GMT (1pm AEST).

If Britain does vote to leave the UK, it won’t be a quick divorce. The terms of departure will need to be negotiated and formalised in a process that could take years.

Market implications

Global Markets

As anyone interested in trading will be well aware, the Brexit vote is looming as a major market risk event. Sure, many of these much anticipated market events turn out to be “fizzers”. However, some do not. The Brexit vote is no different. A whole range of market outcomes look possible. These range from:

  • Not much impact at all
  • Large short term volatility including price spikes; illiquidity and price gaps
  • Major trending moves in the days following the vote.

Traders will have their own views on whether Brexit is a good or a bad thing and so what it might ultimately mean for markets. In general though, the biggest potentials impacts seem likely to be on:

  • The UK economy. Opinion among analysts and economists on the how Brexit will impact the UK economy is remarkably divided. Some believe it will be a negative; others see it as a clear positive and still others believe it won’t make much difference at all. To some extent this may depend on the exit negotiations. The headline markets most in the firing  line here will be:
    • The Pound and
    • The UK 100 index
  • The European economy. There is probably more consensus around the possibility that Brexit could pose political and economic risks for Europe. This centre’s around the possibility that Brexit could open Pandora’s Box. More countries might look to leave the EU at a time when Europe is facing major economic and political challenges. Markets in the firing line here could be:
    • The Euro and
    • All the European stock markets and indices like the Germany 30
  • Safe Haven Assets. Depending on how the vote goes a risk event like this typically triggers a rush into or out of traditional safe have assets. Markets in the firing line here could include:
    • The US Dollar
    • US Bonds
    • The Japanese Yen
    • Gold
    • The Swiss Franc.

The lead up could be important. In recent weeks we had seen some sizeable market moves in anticipation of a possible Leave vote. Gold rallied, stock markets dropped and the Pound was weaker.

With 2 trading days to go before the vote, much of this risk premium has been removed. The betting market is starting to indicate a clear majority for the Remain vote. By Tuesday, the odds of a leave vote had blown out to 3/1. This implies only a 26% chance of Britain voting to leave the EU.

The ASX 200 has retraced about half this month’s losses. The British Pound returned to its May high

As things currently stand, the market clearly sees a reduced chance of a leave vote. The extent to which markets have moved in a risk on direction in recent days might also imply that investors are moving to the view that even if there is a leave vote, the market impact might be much less than many have assumed.

However, by moving in a “risk on” direction prior to the vote, the market has increased the risk of a big negative reaction if they are wrong about theses assumptions. betting markets prove to be wrong and Britons vote to leave the EU.

Impact on Australian markets

While the UK and Europe are important trading partners for Australia and there are many cross investments, the local share market is relatively removed from direct exposure to the UK and Europe compared to many others.

The most immediate impact for the Australian stock market is likely to come from global “risk on” or “risk off” moves.  The local market will be swept up in moves in either of these directions.. Banks are likely to be in the firing line if a leave vote triggers large defensive moves. Potential dislocation to credit markets is always an immediate concern for markets in these situations although central banks will be quick to provide liquidity to avoid immediate problems

Of specific stocks in the ASX 200, Henderson Group PLC and CYBG PLC (Clydesdale and Yorkshire Banks) are two stocks that  listed on London and the ASX and a negative exposure to the Pound,  falling against the Aussie Dollar.  The $A value of ASX shares in these companies would be materially impacted by any significant weakening in the GBPAUD exchange rate.

Other major Australian stocks with significant UK businesses include QBE Insurance; Iress Market Technologies; Westfield Corporation; Goodman Group; Macquarie Group and BT Investment Group.