This is because uncertainty is associated with lower share prices. Economists at Stanford University have compiled an index of policy uncertainty based on text searches of newspaper articles. This index is highly correlated with the dividend yield on the All-Share index; since the data began in January 1997, the correlation has been 0.51. Higher uncertainty is strongly associated with lower equity valuations.
Some shares, however, suffer more than others. Big multinationals are not as tied into the UK economy as smaller stocks, so they should be less affected by local uncertainty. In fact, they might even benefit from it, to the extent that such uncertainty weakens the pound thus increasing the sterling value of overseas profits.
What's more, smaller stocks are more sensitive to investor sentiment than most big ones (apart perhaps from miners) so they should suffer to the extent that uncertainty depresses sentiment.
Simple statistics seem to confirm all this. Since 1997 there has been a high correlation (of 0.7) between the uncertainty index and the ratio of the FTSE 100 to Aim index.
This, however, might not be as impressive as it seems. It might instead be an artefact of the fact that since the early 2000s uncertainty has trended upwards while the FTSE 100 has outperformed Aim stocks, perhaps for separate reasons.
To correct for this possibility, I ran a simple check. I looked at the difference between the uncertainty index and its 12-month average, and compared this to the difference between the ratio of the FTSE 100 to Aim index and its 12-month average.
In this de-trended data, there is also a positive correlation, of 0.24 since 1997. Above-average uncertainty is associated with the FTSE 100 doing unusually well relative to Aim stocks.
The same is true for the ratio of the FTSE 100 to the FTSE 250 or to small-caps: correlations in de-trended data are 0.39 and 0.42, respectively.
Facts and intuition, therefore, seem to agree: uncertainty is worse for smaller stocks than for the FTSE 100 - and, I suspect, the more defensive stocks within the 100. Brexit would therefore be worse for smaller stocks, at least in the short term.
However, this is not a reason for avoiding them. According to Betfair, there is only a 27 per cent chance of Brexit. If, as is likely, 'Remain' wins uncertainty should decline, if only temporarily, which could give smaller stocks a boost. If this happens, though, it would only be a reward for taking on that Brexit risk.
