Thursday is the big day. After the polls close, we’ll know if the United Kingdom remains united or if Scotland will be going it alone. With just a few days to go, the race is a statistical dead heat:
Data from: WhatScotlandThinks.org
Given that we’re talking about the potential breakup of a major banking and financial power, a founding member of NATO, a nuclear power, and a permanent member of the UN Security Council, you would expect the markets to be on edge. Yet investors seem far more preoccupied with the Fed’s schedule for raising interest rates (deliberating the precise date of the Fed’s decision to raise rates by 25 basis points is as inane an argument as how many angels can balance on the head of a pin, but that is another story for another day).
Yes, the British pound has fallen sharply against the dollar over the past two months (see chart, below). But then, the euro has been selling off vis-à-vis the dollar as well, and in any event, the pound‘s declines still puts it in positive territory over the past year. The dollar’s recent strength could just as easily be attributed to the expected tightening of Fed monetary policy.
How should we interpret this?
It would appear that the market is discounting a Scottish “No” vote (i.e. a decision to stay in the Union).
As a general rule, betting markets are more accurate than opinion polls in predicting political outcomes such as elections, which makes sense: people tend to take their answers a lot more seriously when money is on the line. Apart from the action in the capital markets, betting sites would seem to confirm that the United Kingdom will prevail. The odds of Scotland leaving are only about 22%, according to predictions market site Intrade. And gambling site Betfair puts the odds of Scottish independence at about 5 to 1.
Still…what if, perhaps inspired by a Braveheart movie marathon, the Scots surprise everyone and do vote for independence. What happens then?
MarketWatch’s Matthew Lynn argues that a “Scoxit” would be an economic non-event and the rest of the UK would be better off without Scotland, citing, among other things, Scotland’s older, sicker demographics , its higher public spending per capita, and its declining oil revenues. A UK without Scotland would likely be more market friendly and more economically dynamic.
In principle, I would agree. And in the long term—assuming the rump UK didn’t do something suicidal like exit the EU in 2017—Lynn is probably right. But a lot can happen in the meantime.
Here are a few possibilities:
- Scottish banks would flee Scotland en masse for London. The Royal Bank of Scotland (NYSE:RBS) and Lloyds (NYSE:LYG), which owns the Bank of Scotland, have both already indicated they would leave Scotland. Any bank that didn’t leave would be at risk of having no viable guarantor to bail them out during the next crisis. Certain “real economy” companies—think Scotch whisky maker Diageo (NYSE:DEO)—would have a harder time rearranging their businesses. But expect capital and business to move south of Hadrian’s Wall.
- The uncertainty that comes with a “yes” votes spills over into Europe, further undermining Europe’s economic recovery as companies withhold new investment until the dust settles.
- Investors panic that a UK split-up will give strength to separatists in Spain and Belgium, and we return to the “bad old days” of 2010-2012 when it appeared that Europe was coming apart at the seams.
So, what should we do if the Scots vote yes? I would err on the side of caution by raising at least a little cash. I don’t expect a Scottish yes vote, and even if we do get one I would expect the fallout to be relatively contained. We may even get a nice buying opportunity in potential “contagion” markets like Spain.
My advice: Wait and see. If the Scots vote to secede, we could have a nasty correction in European shares. If this happens, use it as a buying opportunity to pick up shares of solid blue chips like Spain’s Banco Santander (NYSE:SAN), BBVA (NYSE:BBVA) and Telefonica (NYSE:TEF)—all solid multinationals with a large chunk of their operations outside of Europe.
But wait for the dust to settle first. I should emphasize that we really are in uncharted territory here. We’ve seen plenty of countries disintegrate in recent decades, with the Soviet Union and Yugoslavia being the two biggest that come to mind. But none has been as systemically important to the world financial system as the UK.
In the meantime…you might need to pour yourself a tumbler of scotch to ease any anxiety going into Thursday’s vote.
Disclosure: Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management.