Some of the most feared stocks in the world right now are European banks, but this also makes them rife with opportunity. With the Brexit vote set for Thursday, June 23, nobody knows what the long-term effects will be, if any, especially on the European financial system, which will be ground zero for trading the vote. The Brexit side was pulling away last week, but with the tragic murder of pro−European Union British Parliament member Jo Cox, there is now no clear leader as the “Remain” camp has regained some lost ground in recent polls. This makes the situation even more confusing and European bank stocks that much more feared.
Yet, if we step outside for a moment from the turmoil, there might be a relatively safe way to trade the Brexit vote without staking your position on any particular outcome. The first thing to consider is that European bank shares have been absolutely dismal performers since the 2008 financial crisis, though that is not unique to them as few banks shares have recovered their pre-2007 highs. What is more notable though is that many big European banks have performed even worse since 2014. Since January 2014, Germany’s Deutsche Bank A.G. (NYSE: DB) is down over 70%. Credit Suisse Group A.G. (NYSE: CS) is down over 60%, both well below 2009 lows. Royal Bank of Scotland Group PLC (NYSE: RBS) is down 33% and Barclays PLC (NYSE: BCS) is down over 37%. This sort of horrific price action already limits downside in these stocks.
Until the vote on Thursday, European bank stocks may prove volatile with each new poll but probably won’t move much more on net until the results come in. If the Brexit vote fails and the United Kingdom remains in the European Union, it is almost a given that we will see some kind of relief rally with the epicenter on European financials. These stocks may not be the best to hold long term, but they almost certainly would rally sharply short term on a vote to remain in the EU.
But what if Brexit passes and the United Kingdom votes to leave? In that case, bank stocks in Europe probably would tank on the unprecedented uncertainty, but that does not mean that short-term traders cannot take a position before the vote. It only means that a full position should not be taken before the vote. On a vote to leave the EU, the European Central Bank has made it clear that it will flood the eurozone with liquidity with open currency swap lines, and the Bank of England likely will do the same with other European central banks. If Brexit passes and the United Kingdom votes to leave, traders can buy the enormous dip that is sure to come and wait for central bank injections to levitate financial stocks back up.
Since the referendum is not officially binding until the U.K. parliament votes to honor it, there will be no immediate break from the EU regardless. This buffer will give European financials time to absorb the new reality and come back to pre-Brexit vote levels (which are already dismally low) on any financial rescue. If risk-oriented traders have the courage to buy the dip and wait for these stocks to get near pre-vote levels after the European Central Bank and Bank of England rescue their respective banks, they can then lock in those gains if Brexit passes.
And if not, traders can simply lock in the relief rally gains the minute the United Kingdom votes “Remain.”
In a sentence, traders can go to half positions before the vote either way, and then sell on “Remain,” or add to full positions on Brexit and sell at or near pre-vote prices on central bank action.