- Four asset classes to watch: Currency, Equity, Bonds and Property.
- Article focuses on movements if Britain leaves.
- Opportunities from safe haven currencies, such as USD/Yen, and exposed currencies, such as GBP/USD.
- Large cap UK equity likely to perform better than mid and small cap.
- Safe haven bonds, such as German Bund, will likely see yields fall due to combined effects of deflation fears in EU and uncertainty if vote leave.
- CFD and spread betting are potential trading platforms for a small investor (£10 to £1000), commissions are smaller than a flat-rate brokerage and platforms are easy to use.
In this post I will go through a number of asset classes such as Currency, Equity, Bonds and Property, to help understand how the market may move following a Brexit situation i.e. UK voters decide to leave the EU on the 23rd of June. I will investigate some general trends in each asset class before concluding with some ideas of how a small investor (£50 to £1000) may be able to place some trades.
The Brexit referendum offers great opportunities for trading because of the sheer scale of the decision. It is likely that if the UK leaves it will not be invited back and there is no certainty that favourable trade deals will be made anytime soon. As a result the UK is expected to have a weaker economy and the markets will decline over the uncertainty. For these reasons I focus on the leave situation. A remain vote would likely see a rally of all assets mentioned, however, due to the certainty of remaining, the effect will be less pronounced.
The main currency to observe here is GBP/USD (see Figure 1), which is currently trading at 1.4878 (23rd June), this is up from 1.41 only one week ago – suggesting the markets are pricing in a Remain.
It has been argued that the pound is likely to fall as much as 18% to $1.20/£1 in the case of an exit. This is unsurprising, since January the pound has seen tremendous volatility (see Figure 2) surrounding the Brexit decision.
The pound sterling has fallen from 1.477 at the beginning of the year to a low of 1.386 on the 28th February, following Boris Johnson’s announcement to join the leave EU campaign. Since then the Pound has fluctuated from 1.40 to 1.47
The trade: Short GBP/USD.
The second currency is the USD/Yen. In the uncertainty of a EU-less UK investors will seek out safe haven assets, one of which is the Japanese Yen. Its safe haven status originates from a large trade surplus and, of course, market participants following each other. Since January the Yen has seen a large appreciation against the dollar (see Figure 3), appreciating from a low of 121 on the 1st of February to 104 presently (23rd of June), down from 110 at the beginning of the month.
Following the Bank of Japan’s (BoJ) decision to maintain interest rates at their meeting on the 16th of June the Yen has continued to strengthen. A strong Yen is detrimental to Japan’s attempts to revive their economy; therefore whilst this trade appears to be a sure thing (see Figure 3) it might go in the opposite direction if the BoJ decides to implement currency-weakening policy (e.g. lower interest rates) at their next meeting.
The trade: Tentatively short USD/Yen.
The second major asset class is equity. Investigating UK equity it is likely that a Brexit will cause a general fall in the stock market, as investors sell on the uncertainty of the UK economy and of favourable trade deals being secured. The weak GBP may benefit UK firms, as exports become cheaper thus increasing their demand. However inflation pressures and lack of trade may outweigh this benefit, and their goods will be worth less so there could be supply-cost issues. In the short run large caps will benefit more than small caps, this is because the FTSE100 stocks have an international focus and significant operations abroad. Thus a weaker GBP implies that their profits abroad will be worth more, helping even their bottom line. It is also likely that less cyclical stocks will perform better than their cyclical counterparts (due to the uncertainty of Global and British economic growth and trade). Thus Miners, whilst having an international focus, may perform poorer than more stable industries such as consumer staples and utilities. Property stocks will perform badly, this is discussed below.
The trade: Long large cap stocks with international operations (e.g. Vodafone, BP). Avoid cyclical stocks and property.
All stocks are unique and must be treated so. There may be other parameters that need to be considered apart from just a Brexit situation.
Recent falling yields on safe haven bonds, such as the German 10-yr dropping below 0%, indicates an opportunity for profiting. Should the UK leave the EU we will likely see an appreciation in safe haven bonds, such as the US treasury bill and the German Bund. The bund in particular may be a good trade, as EU disinflation is also putting downward pressure on the yield. However with the 10-yr already falling into negative territory I would be cautious on buying, as it may well be that the bond market has already heavily priced in the Brexit situation.
The trade: Long safe haven bonds: US treasury and German Bund.
Property is likely to see a decline for two reasons. Firstly a weaker pound, as discussed previously, will put upward pressure on import prices. If inflation materialises the BoE may be forced to raise base interest rates to stabilise prices towards its annual target of +2%. Higher base rates will increase the cost of mortgages, thus reducing demand for property. Secondly, the UK will likely see a fall in the London property market, which could lead to the so-called London-bubble bursting, as foreigners become more uncertain over the future of the UK and are less attracted to a country which no longer has those beneficial ties to the continent.
Both of these reasons will weigh on property stocks, likely causing them to fall. As we see in Figure 4 since January property stocks have taken a hit in the build-up to Brexit, falling -10%, in particular for the second reason.
The trade: Short property. Property stocks include: Persimmon, Berkeley Group, Barratt Developments and Hammerson.
Above I have briefly reviewed each asset to see how they might trade following a Brexit, but I’m aware that as a small investor is can be difficult to capitalise on these movements. Due to commission costs of between £7 to £12 a trade it can be exceptionally expensive to trade with a small amount of capital. A purchase of £100 of Vodafone shares costs you £7 to buy and £7 to sell, therefore you would have to earn a minimum of 14% to just cover the costs of trading.
There are, however, alternatives available where you can trade with as little as £10. I must note, although the commissions for these platforms are miniscule compared to brokerage accounts, the trades are highly leveraged. I highly recommend you set-up demo accounts to familiarise yourself with the platforms.
The two types of trading platform I will go through are Contract for difference (CFD) and Spread betting.
CFDs are a derivative that allow you to benefit from the price movement of an asset, without actually owning it. The margins can be as low as 2%, therefore if you want to trade £1000 worth of Hammerson property stock, it may only require an investment of £20. If the stock goes up 10%, you make £100 – from your £20 investment. However the opposite can occur, and you could be paying out £100 to pay for the difference.
Example platforms for CFD trading:
- Free £20 welcome bonus.
- Demo account.
- Easy to use.
- Can create groups and is therefore used by finance societies at university for trading competitions.
- Premiums to pay at the end of each day if contract still open, therefore best used as day trading platform.
- Lowest charge for trading GBP/USD: 0.9 pts variable.
- Free £20 welcome bonus and first £100 deposit receives £100 bonus.
- May be charged for withdrawing under £100 of profit.
- Benefit from the Barclay’s network – better customer service.
- No annual fee, £5 a trade.
- Product quite clunky and old school.
Spread betting is similar to CFDs except it does not involve derivative contracts, in this case you are simply betting on the movement of a stock – akin to placing a bet on a football game. In fact some of the largest providers of spread betting are gambling companies.
Example of spread betting: You place a spread bet on the UK FTSE100 of £0.10. Every 1 point movement upwards you gain £0.10, and every 1 point downwards your lose £0.10.
Spread betting companies (most spread betting companies have CFD trading, however vice versa does not necessarily apply):
- Great for beginners, they have a particularly useful ‘how to’ guide for spread betting.
- CFD trading.
- No deposit required, no minimum account holding.
- 24 hour trading and demo accounts.
- 25p movement minimum
- Option for binary betting (bet on rise or fall by end of day).
- Established brokers, CFD, spread, shares, forex.
- Beneficial if you think you will trade forwards past just Brexit.
- £1 movement minimum is quite high.
- Need minimum £100 account holding.
- 0.5% deposit.
- The cheapest option.
- No minimum account holding, only 0.2% margin deposit, 0.10p movement minimum.
- May suffer on customer service front from cheaper cost.
An important factor to consider when deciding on spread betting is that it is tax free – as long as it is not your sole source of income. This has advantages for investors looking to dabble in the market and diversify investments/savings.
The author bears no responsibility for the trading actions of the reader following this article, this information should not be relied upon as an alternative to qualified professional financial advice.