Tyler Durden: Despite the exuberant rally in stocks following the dreadful murder of UK lawmaker Jo Cox last week, investors are anything but convinced that everything is awesome.
As polls show the Brexit vote remains very evenly-matched, so traders have piled into short-term VIX protection (covering the next few days) spiking from 11 to 22 in the last week.
This is the widest spread to ‘normal’ VIX since the August crash following China’s turmoil-inducing currency devaluation.
As Macro Risk Advisors strategists believe the VIX is too low and options traders are underpricing the risk of a British exit from the EU.
Here is what the major banks believe will happen: BREXIT WIN SCENARIO
- Base-case index target for the FTSE 100 in case of ‘leave’ is range of 5000-5300; for the Euro Stoxx 50 is 2400-2550
- Sees European stocks moving 10% either way after Brexit vote; “leave” result would be risk-off event not just in U.K. but also Europe and, to a lesser extent, globally
- Sell-off in Europe could translate into 6%-7% drop for S&P 500
- “Un-quantifiable risk” whether other EU countries would then attempt to leave EU
- Recommends long European low-risk dividend stocks, long SXDP index vs short SX3P index, long European index dividend futures, long MSCI EM
- On average, the ERP (equity risk premium) has risen by ~150bps in past risk-off events. If Brexit were to result in similar scenario, rise in ERP of 150bps from end-May levels would push Stoxx 600 down to 280 and Euro Stoxx 50 to 2400
- Cleanest expression of Brexit risk is in U.K. domestic stocks (GSSTUKDE) and especially those with high sensitivity to investment spending
- In ’leave’ scenario, euro-area equities would likely underperform U.K. ones, whose relative performance would be helped by GBP weakness
- Stays overweight on U.K. equities, which trade “outright cheap” on P/B metric
- Given recent equity weakness, likely policy reaction, new oil price regime, base-case Brexit downside risk is ~5%; at extreme end of the outcome spectrum, European stocks could fall 10-20%
- FX weakness, especially in U.K., is a key offset and should, in time, support positive U.K. returns, excluding return of full-blown systemic risk
- Sees 10% downside for European equities
- Overweight FTSE, underweight DAX: if Brexit, U.K. equities would outperform European stocks, given likely GBP depreciation as well as U.K. market’s defensive sector structure
- Sees 5%-10% decline in FTSE banks, euro-zone banks falling by at least an equivalent, if not greater percentage
J. Safra Sarasin
- A yes to Brexit would probably take equity markets down another 8%-10%
- Favors U.K. pharma, tech, chemicals stocks in case of Brexit
Finally, with UK Economic Policy Uncertainty (EPU) at current highs, in the case of “Brexit” the US EPU may rise substantially, pulling the VIX higher.
VIX may reach high 20’s to low 30’s if US EPU spikes. After languishing in the low teens over the past several months, last week the VIX broke through 20 for the first time since March.