EU referendum uncertainty weighs on UK in H1 2016

Beyond risk premiums which are incorporated into European equities, political uncertainties have started to weighs on business indicators.

With six weeks to go until the EU membership referendum, the sharp deterioration in UK leading indicators reveal the uncertain business environment and the loss of momentum. Of note, recent business trends in the UK are sending divergent signals compared to the Euro zone.

The Q1 2016 GDP release showed that the UK economy lost momentum at the start of the year as its growth rate remained at its lowest level since 2013 (0.4% QoQ, 2.1% YoY). Against recent global trends, we note a continuation of this weakness and even a deterioration in leading indicators across the board. For the first time in three years, the April PMI manufacturing survey has fallen into contraction territory, well below market expectations (49.2 vs. 51.2 expected). March industrial production grew less than expected (0.3% vs. 0.5%), signalling a second straight quarterly decline.

Outside the industrial sector, which is now effectively in recession, services and construction have also slowed down considerably in recent months but remain in expansion. Last month, UK consumer confidence declined to its lowest level since December 2014. Clearly, mixed messages about the post-Brexit world have increased doubts over household’s faith in their economic outlook. In any case, H1 2016 appears increasingly as a soft patch for the overall UK economy.

In terms of asset allocation positioning, we take cross asset inconsistencies regarding Brexit risks into account. In particular, we think that small and mid-caps in the UK are not adequately reflecting the deterioration in domestic business conditions.