Investors may be underestimating British resolve to leave the European Union, and that could firmly plunge Europe’s stocks into a full-blown bear market.
That’s according to a Monday note on so-called Brexit worries written
by a group of Morgan Stanley economists led by Jacob Nell. The note
suggests that European stock investors may be caught flat-footed in the
event the U.K. votes in favor of exiting the EU.
Morgan Stanley said European stocks are susceptible to pitching lower
because they already had been under pressure due to concerns about
sluggish eurozone growth. Combine that with European equities’s tendency
to be more volatile than their U.S. counterparts and it is a recipe for
a potentially steep Brexit-fueled selloff, Morgan Stanley said.
The Stoxx 600 Europe Index is already down 18% compared with this
time last year, and 12% off year to date. Meanwhile, the S&P 500
index is down 1% from this time last year, and up 1% year to date.
“At our European equity conference last week, only 5% expected the UK
to vote for Leave,” Morgan Stanley said. “Maybe it is exhaustion over
‘political false alarms’ in Europe, or confidence that this is an issue
that markets can take in their stride.”
In a poll of 42 clients, Morgan Stanley found a majority expect an up
to 10% decline in European stocks three months following a Brexit, with
a third of respondents expecting a drop of up to 20%. When Morgan
Stanley took their poll, 60% of investors they surveyed estimated that
55% or more of Britons would vote to remain in the EU.
That kind of safety margin has slipped away as the U.K. referendum
scheduled for June 23 approaches. One recent poll shows 47% back an
exit, while 40% wish to remain. Another poll showed 46% supporting an
exit, up from 42% the previous week, while only 39% supported staying,
and a Guardian/ICM poll showed 53% support for leaving.
Should the U.K. vote to ditch the EU, known as Brexit, Morgan Stanley
expects a 10% to 20% decline in European stocks, but sees that playing
out over a longer time frame than three months. A so-called bear market
in an asset is traditionally defined as drop of 20% or more from a
“Within the European market, we would not expect to see a material
divergence between UK or eurozone equities,” Morgan Stanley noted.
“However, we do believe that large-cap stocks in both regions would
outperform,” the firm added. “At the sector level, internationally
exposed defensive sectors such as Staples and Pharmaceuticals would
likely outperform at the expense of Financials and domestically focused
Should the U.K. decide to stay in the EU, then the form expects a relief rally in the mid-single digits for European stocks.