Citigroup suggests four hedges against Brexit

Citigroup reckons there is a 20-30% risk of ‘Brexit’, perhaps even as high as 30-40%, so while it’s not the bank’s base case, it is “by no means a trivial risk”.

“The effects of Brexit, if it happens, are likely to be large and painful in economic and political terms, both for the UK and the EU as a whole,” said Citi.

It could spark significant economic weakness for the UK, with a 15-20% depreciation of trade-weighted sterling, resultant return to import-driven inflation and a major policy dilemma for the Monetary Policy Committee.

It would also likely prompt a wider wave of referendums and embolden other separatist movements within the EU, the bank said.

Citi said that while some of the factors above would present stiff headwinds for UK equities, a sharply weaker pound tends to be supportive of UK share prices in GBP, if not USD, terms.

UK plc derives only about 30% of sales and profits from the UK, Citi noted, adding the global economy and commodity prices hold greater importance for UK stocks in the next 12-18 months than Brexit.

Still, to protect against a Brexit scenario, it might not be a bad idea for investors to opt for cash in the near term.

“But, we would also suggest that investors try to protect against the risks presented by falling GDP and GBP.”

Citi suggested four hedges: overweight energy/underweight financials; overweight tobacco, mobile telecoms, pharma and household goods versus underweight food retail and non-life insurance; overweight FTSE 100 versus underweight FTSE 250; own US-exposed strong balance sheet stocks with surplus free cash flow.

As the bank took a more positive view on the energy sector, it cut Barclays from its ‘Focus List’ for Europe, replacing it with Total.

As far is Brexit is concerned, it sees three key risks: “political instability with the likely resignation of Prime Minister Cameron and a second Scottish independence referendum, significant uncertainty and slowdown from UK economy as business/consumer confidence takes a hit, and a sizeable drop in GBP.

“Of these, it is the likely economic and FX impact of Brexit which is most important for UK equities.”