Amongst other factors, uncertainty around the UK Referendum has resulted in a number of investors exiting European equities. Pan-European equity funds have seen $32bn of outflows YTD at a time when global equity funds have enjoyed $14bn worth of inflows. Our work suggests that within equity markets, investors have already priced in a high probability of a potential vote to leave the EU.
Elevated risk premia: The uncertainty has manifested itself with both the equity risk premium and implied volatility on European stocks versus the US now near historical highs. In the UK, the PE discount on the FTSE 250 vs. FTSE 100 is now near financial crisis highs.
Domestic de-rating: Domestically focussed UK stocks have been de-rated vs. $-exporters to a 1 standard deviation low on PE. Our calculations suggest that investors are pricing in a near 20% decline in EPS for UK domestics. This is despite these stocks having enjoyed EPS upgrades recently, implying that a potential vote to leave is somewhat “priced-in”.
Referendum “in the price”: Similarly, investors have de-rated UK Discretionary stocks vs. Staples to levels that have been associated with a collapse in UK consumer spending growth to zero. That being said, if the UK were to vote to leave the EU, the impact on stocks would probably be negative. However, with betting odds signalling a declining probability of a “leave” vote, we feel that European equities, specifically UK domestic stocks, perhaps look underpriced. We add Next to our European recommended portfolio.