Brexit: The point of maximum fear

by | 22 April 2016

Following his recent paper ‘Brexit | Logic Dictates’, Dr Walter Boettcher, Chief Economist, Colliers International UK discusses pre-EU referendum ‘fear’ – and whether there is any such time where it will reach a maximum – a time where investors should be ready not just to buy, but also to sell.

It is often said that if you repeat something often enough, you will eventually come to believe it, even if you have forgotten its basis in reality. Any such remark presents the risk of being called to account, as has been aptly demonstrated recently in the EU referendum debate.

One such remark I have been making recently is that at the point of maximum pre-referendum fear, investors should buy commercial property – ‘hoover up’ was the exact expression – because ‘. . . there must be at least 50 bps of yield compression waiting on the other side’.  In common language, this means that if you buy at this point of fear, you will profit substantially (10% to 15% for prime property assets).  This, of course, assumes that a vote ‘to remain’ in the EU is the all but certain outcome.  For veteran property analysts, I intended the comment to be received less as real advice and more as a rhetorical, if glib, device to liven up discussions. Surprisingly, several seasoned investors in my sundried audiences admit to sharing the view and were pleased to have heard it presented in a ‘legitimate’ forum. Consequently, I was challenged not to justify the argument, but to identify precisely the point of maximum pre-referendum fear so that investors could be ready.

I was at MIPIM, and I do not remember offering a date, but apparently a date I did offer . . . May 23rd to be sure. I was reminded of this by an e-mail from a senior fund manager of a very large fund who did not see May 23rd as a buy opportunity, but rather as a sell opportunity for assets deemed no longer fit for the fund.  The key takeaways here are: (1) investors accept that there is a point of maximum fear; and (2) willing buyers and sellers exist so by definition a fear market exists. On March 23rd, the Financial Policy Committee finally identified that the EU Referendum posed a risk to UK financial stability. My comment was, therefore, not at all glib, but addressed a palpable fear that is now officially part of the UK financial stability equation.

As for the date, it is linked to data releases, political events, media coverage and how these conduits feed the fear.  On April 27th, the ONS first estimate of GDP for Q1 16 will be released; it will disappoint. On May 5th, Markit services purchasing manager indices may show the UK flirting with economic stagnation. UK local elections also fall on 5th May; a new London mayor will be elected and the Tories are fielding a pro-Brexit candidate. Public finance data, employment data, oil prices, CPI, RPI, UK exchange rates, bond ratings, not to mention European and US politics which some see as a greater threat than the EU referendum, these are all there in the runes to be read.

On Monday May 23rd, one-month sterling futures contracts will begin trading and, for the first time will begin to cover referendum day on 23rd June. Hedging against the EU referendum impact has already begun, with longer dated contracts suggesting a considerable fall in sterling should the UK vote to leave.  The pound has already been weakening and, on a trade weighted basis, is down 7.8% since the beginning of the year.  Capital Economics also shows that risk reversals on $/£ options show that ‘. . . the drop in six-month risk reversal is far larger than that seen around other recent political events.’  When one-month contracts begin to trade, the pound may plummet and a plummeting pound may prove to be the point of maximum fear when the ambivalent and indifferent are exposed to what is potentially at stake for UK business and property.

This post was originally published by Colliers International United Kingdom. For more Research and News from the UK team see http://www.colliers.com/en-gb/uk/insights