by Tom Stevenson, Investment Commentator at Fidelity

26 April 2016

The job of stock investors is to discount the future. They attempt to price in what’s coming down the track rather than what’s happening today. It is entirely reasonable, therefore, to expect investors to be starting to factor in the probable outcomes of the UK referendum on EU membership in June.

This is not easy for two reasons. First, the opinion polls have started to converge on a 50:50 split between remain and leave, with a significant number – perhaps a quarter of voters – undecided. Placing a big bet on one or the other outcome looks risky at this stage. Second, there remains considerable uncertainty about what either outcome – but particularly leave – would mean at the stock or sector level.

That said, an analysis of likely winners and losers by UBS does seem to point to an early attempt by investors to reshape equity portfolios in anticipation of the vote. Since November, a basket of the expected winners from a Leave vote has outperformed the likely losers by more than 10%.

That could provide a template for adjustments to portfolios as June 23 approaches. An increased likelihood of Brexit would argue for a continuation and exaggeration of recent trends. If a victory for the remain camp looks more likely, it should pay to reverse the bet and weight portfolios towards recent underperformers.

UBS asked its analysts a simple question: would Brexit increase earnings per share for the companies they followed by a material amount. If it would, then the company was placed in the relative winners list; if it would move earnings down significantly, they joined the list of relative losers.

Part of the equation is clearly exposure to the domestic UK economy. This reflects the widely-held expectation that, in the short term at least, the UK would suffer from a slowdown in activity as the implications of leaving the EU were assessed.

The second key consideration is the exchange rate. UBS’ base case is for the recent underperformance of the pound to continue in case of a Brexit outcome, with a cumulative depreciation of up to 30% on a trade-weighted basis. The pound has already fallen by about 8% year to date.

The consequences at the sector level are not rocket science. If you expect a slowdown in GDP growth then, broadly speaking, domestically-focused stocks in the FTSE 250 mid-cap index will be more heavily impacted than the internationally-exposed companies in the FTSE 100. That effect is already becoming apparent, with the mid-caps reversing their multi-year outperformance of the blue chips since the beginning of 2016.

Housebuilders and real-estate companies, which tend to be wholly or largely UK-focused, are vulnerable to slowing GDP and lower levels of immigration. Interestingly, food retailers are also dependent to a larger degree than you might imagine on population growth in an otherwise mature and disinflationary environment.

A slowdown in the property market and related reductions in consumer confidence would be bad news for banks. Financials might also be vulnerable to the disappearance of “passporting” rights in the single market.

For other sectors, things are less clear-cut. Travel and leisure companies might benefit from a lower pound if it made holidays in the UK more attractive but this would be offset to a degree by any slowdown in GDP growth. European companies for whom the UK is a significant market (luxury car-makers, for example) would not welcome a reduction in British consumers’ spending power on the back of a weaker pound. A drop in sterling would hit general retailers, which tend to source their stock in dollars or euros.

In terms of the UK market’s absolute and relative valuation, referendum uncertainty has compounded an already lacklustre picture. The UK has de-rated in recent years thanks to its heavy commodities and energy weighting. Having stood at a reasonable premium to shares in the rest of Europe, comparing share prices to the value of underlying assets, British shares are now at a small discount. Compared to history they are relatively cheap too.

With the delayed impact of currency weakness yet to feed into earnings and the drag from weak commodity prices falling out of the comparisons, the risk/reward balance for UK shares is starting to look more favourable. The one area where there might remain an opportunity is in the relative valuations of defensive and cyclical stocks, where recent uncertainty has pushed investors even deeper into safe-haven territory. Sectors that are considered relatively immune to the ups and downs of the economy – tobacco, household products, utilities and telecoms, for example – are considerably more expensive even than they were last time the market got seriously flustered about Europe in 2012.

If we wake up on June 24 and remain in the EU, then cyclical, value stocks may look rather interesting compared to their more defensive, high-quality counterparts.

Important information

References to specific securities should not be taken as recommendations.

Investments in small and emerging markets can be more volatile than developed markets.

Investments in overseas markets can be affected by currency exchanges and this may affect the value of your international investment.