UK stocks face a potential Brexit shock

UK stocks have so far proved fairly immune to EU referendum polls suggesting an exit is almost as likely as a vote to remain. That will change if the UK electorate does vote for a Brexit. So which stocks are most insulated from, and which most exposed to, a potential vote to leave?

UK stocks have so far ignored the risk of a potential Brexit, and those with greater exposure to EU markets have actually outperformed peers who generate more earnings outside the block. But that’s likely to reverse if the UK’s referendum vote falls in favour of leaving the EU.

The relative outperformance of stocks with an EU focus could be down to the drop in the pound. Sterling has taken a hit since the referendum date was announced last month, but that inflates British companies’ earnings from the EU when translated back into the UK currency.

There is a huge amount of uncertainty about the short and long-term impact of Brexit on UK stocks, just as there’s plenty of uncertainty about the impact on the British economy, but investors should be aware of which companies are most exposed and which are most insulated from such a scenario ahead of the vote on June 23. Despite the apparent lack of concern about the referendum in London’s equity market, the focus is only going to intensify as the referendum date approaches.

The FTSE 100 is generally deemed to be better insulated from a Brexit than the FTSE 250. That’s because many FTSE 100 stocks have multi-national exposure – energy companies like BP and Shell, miners BHP Billiton, Rio Tinto, Anglo American and Glencore, pharmaceutical giants like GlaxoSmithKline and AstraZeneca and tobacco companies British American Tobacco and Imperial make a lot of money outside the UK and EU. They’ll also benefit from a likely further fall in the value of the pound once they translate their overseas earnings back into sterling.

Not all FTSE 100 stocks are immune to a Brexit
There are, of course, plenty of exceptions within the FTSE 100. Banking stocks are highly exposed to a potential Brexit and not just because of their UK retail banking operations. They also fund the trade flows between the UK and its biggest trading partner, the EU. And some analysts say the recent sell-off in UK commercial and residential property stocks could partly be down to fears of a Brexit, as investors become more nervous about putting their money into the relative safe haven of the London property market ahead of the vote.

There’s another reason some FTSE 100 stocks may suffer if investors become more nervous about the Brexit vote. If US investors get jittery ahead of the referendum, they could decide to pull investments from the UK. Stocks with a high proportion of US investors on their share registers include pharma company Shire, gold miner Randgold Resources, luxury goods company Burberry and do-it-yourself retailer Kingfisher, the owner of B&Q and Castorama.

FTSE 100 companies who make most of their money in the UK are also deemed to be at risk because of the potential impact of an EU exit on domestic growth and consumer and business confidence. Clothing retailers Next and Marks and Spencer Group, food retailers Tesco, Sainsbury (J) and Morrison WM Supermarkets and the London Stock Exchange are among those falling into this category.

Beware also low-cost airline easyJet, which has already warned of the hit it is facing from potentially losing the ability to negotiate good deals with EU airports. Ticket prices would have to rise, it says, which isn’t good news for a budget airline trying to compete on price.

US exposure provides some immunity
Aside from the multinationals, investors should be looking for companies with strong balance sheets and high US exposure if they’re looking for some protection against the risks of Brexit. Plumbing supplies business Wolseley, consumer goods giant Unilever, media buyer WPP and technology stock ARM Holdings are among this group, as are utility firms like Centrica and SSE, and aerospace engineer Rolls-Royce Holdings.

The longer-term impact of a Brexit on these stocks is unclear, but US President Barack Obama’s warning that it could take up to a decade for the UK to negotiate new trade deals with the US needs to be heeded whether you believe him or not.

FTSE 250 is more exposed to a potential Brexit
Stocks in the FTSE 250 are deemed to be more exposed to any fallout from a Brexit. That’s because far more of them make most of their revenue and earnings in the UK or the EU. The UK economy is set to take a hit in the short-term, with Gross Domestic Product growing more slowly.

While the FTSE 100 has risen 0.5% so far in 2016, outperforming a 4.1% decline for the DAX in Germany, the FTSE 250 is down 2.6%. Of course, it’s impossible to say how much of the FTSE 250’s underperformance relative to the FTSE 100 is down to Brexit fears, and there are other factors at play like the recent improvement in oil and some other commodity prices that’s help lift the hard hit blue-chip mining and oil stocks.

However, there’s plenty to worry about for the mid-cap companies: the potential hit to UK business confidence, uncertainty over foreign investment and access to capital flows, potential disruption to company supply chains and their ability to access EU markets, and potential increased volatility in the pound.

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