From Seneca Investment Managers' public marketing material. Seneca is now part of Momentum Global Investment Management.
First it was David Cameron, then it was Gordon Brown, now it seems the markets have taken over the lead role of campaigning to stay in the EU. As the likelihood of Brexit has risen in recent days and weeks, sterling and equity markets have tumbled while safe haven Gilts have risen, presumably an indication of just how awful a vote to leave would be. The question is, how many people will this message from the markets sway?
"It would be stupid and reckless of me to say otherwise when the polls are so close"
This is not about facts any more, though I’m not sure it ever was. No one knows whether it would have been better to have been outside the EU these last few decades. And no one knows whether it will be better or worse to stay in. No, it is now down to pure psychology: the extent to which voters are either scared of the unknown or prepared, enthused even, to leap into it.
At the time of writing, the betting markets have the probability of a vote to stay at just over 60%. This is despite recent opinion polls putting the leave campaign ahead by a couple of percentage points or so. In other words, the betting markets are saying that the polls are wrong.
It wouldn’t be the first time. Despite adjustments that the polling companies make to ‘raw’ polling data, there are certain things they can’t account for, at least not accurately. For example, which way will the large number of undecided voters swing? Second, as alluded to above, to what extent will voters take note of the fears that are being very clearly expressed in financial markets? Third, voters may well express an opinion that is based on principle when polled that they may well not adhere to in the austere atmosphere of the polling booth. Fourth, it is not clear how voter turnout might upset the polls.
I can appreciate both sides of the argument - it would be stupid and reckless of me to say otherwise when the polls are so close. I can understand that many Brits are disillusioned by and mistrustful of politicians and the members of the so-called economic elite with whom they often fraternise. They may not care about the risk of being financially worse off if they can feel personally empowered in other ways. On the other hand, there are many who believe that while the club that is the EU is not perfect – in any club there are always going to be rules that members find irritating – it is better to be in one than not in one. (It’s more complicated than this of course but I think this summary captures the essential sentiments on both sides, if not the formal arguments of those leading the campaigns).
As far as the psychology is concerned, the 2014 Scottish independence referendum provides a good guide. There was a very similar pattern in that, in the lead up to the vote, the polls and betting markets narrowed sharply and as a consequence financial markets got the jitters. When the time came, the vote to stay (“No”) won comfortably, 55.3% to 44.7%. Furthermore, the turnout was a very high 84.6%.
In the UK referendum. the remain campaign is not hindered by the “No” label, the negativity of which may well have made the Scottish vote closer than it would otherwise have been.
My view is that the aforementioned psychological considerations will favour the ‘remain’ campaign more than the ‘leave’ campaign and that, like the Scottish referendum, the outcome will not be as close as the polls are currently suggesting.
If I’m wrong, what then?
Even in the event of the ‘leave’ camp winning, I suspect sterling and equity markets will bounce in the immediate aftermath of the vote. This is the nature of markets. The situation is akin to Pascal’s wager, in which the great 17th century mathematician argued that there was no downside to believing that God’s exists – if you were wrong, it didn’t really matter. Similarly, there is one can argue no downside today to investors taking the view that the ‘leave’ campaign will win and selling their shares. Yes, you might not capture upside, but you won’t lose money. The utility of not losing it seems is far greater than that of winning, also known as loss aversion.
The logic of this argument is flawed, but then reason has rarely been the driver of markets in the short term - that role has been taken jointly by ‘fear’ and ‘greed.’ The fact is, it is always more dangerous to sell than to not sell. If you are sell and you are wrong, you incur a permanent loss, albeit an opportunity loss. If you don’t sell and you are wrong, you just have to wait for things to recover, as they almost always do. The loss is very likely temporary, and thus not permanent.
This is the view we have taken at Seneca. We are slightly overweight equities because we think they are generally cheap and the economic outlook, while not great, is OK (and in the case of our UK companies we think they can thrive either way). We are prepared to ride out short term volatility to the extent our already diversified multi-asset funds are exposed to it, and we would strongly encourage others to do the same.
Published in Investment Letter, June 2016
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.