European stocks may tumble 20% if ‘Brexit’ happens: Morgan Stanley

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 recent peak.
“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 cyclicals.”
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.
Source: MarketWatch