Uncertainty about the Brexit vote may be the greatest danger to markets right now. People simply have no precedent for how US markets could be affected by Britain leaving the European Union.
Two recent reports, one led by Citigroup’s Tobias Levkovich and another by FactSet’s John Butters, attempt to quantify how much exposure US-based companies actually have to the turmoil across the Atlantic.
Levkovich looked at the S&P 500’s (^GSPC) exposure to all of Europe, instead of just the UK. Even considering that, he found that the exposure was not that high.
“With Europe directly accounting for 9% of S&P 500’s constituent sales, of which a good chunk comes from stable businesses in areas like food, drugs and beverages, a Brexit vote is unlikely to be disruptive,” Levkovich noted.
Given that people are likely to keep buying these necessities, regardless of a Brexit, the main direct damage to sales will likely come from the swing in foreign exchange rates instead. The pound and euro may weaken as a result of voters voting to leave the EU. The volatility over the vote may also cause investors to start converting all sorts of currencies into dollars, (as it is seen as a “safe haven”) causing the dollar to strengthen, while the pound and euro are already weakening. A strong dollar hurts exporters, making goods more expensive and less competitive in overseas markets. Furthermore, overseas sales become worth less when they’ve been converted back into dollars.
The FactSet report breaks down the S&P 500’s exposure to the UK by sector, which can be seen in the chart below:
The overall S&P 500 index has a mere 2.9% sales exposure to the UK, FactSet estimates, and even the most exposed sector only has 6% of sales coming from the UK.
However, Butters does note that earnings have already been poor so far, so Brexit’s small impact on earnings is still something to be wary of. Q2 2016 earnings for the S&P 500 are already predicted to decrease 5.1% year over year - making it the fifth quarter in a row that earnings have declined. This is an unenviable trend that hasn’t been seen since the financial crisis.