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Day One After the “Brexit” Vote –Life Goes On

Day One After the “Brexit” Vote –Life Goes On

Guest Post - Friday, June 24, 2016

Contrary to what some experts assumed and last-minute polls indicated, U.K. voters opted to leave the European Union (EU).  The most recent polls had indicated that the Brexit would fail by a small margin, so this outcome was a surprise to the financial markets which had been anticipating a “Bremain.”  The final tally was 52% to 48%.  Here's our take:

In a nutshell, why did this happen? 

Those who supported the Brexit voted primarily to control Immigration and to assert autonomy from the wide scope of detailed regulations of the EU.  The Syrian refugee crisis and terrorism concerns have exacerbated these concerns.  From an economic perspective, many Brits believe that the UK has paid much more into the EU than it has received in benefits, and they feel they’re paying to solve problems other European countries have created.

How have the markets and asset classes reacted? 

Financial markets around the world reacted dramatically this morning, mostly due to the surprise of it all and the uncertain prospects of what this means for the UK economy, and that the remaining EU countries.  This has led to a drop in the British pound, which has been falling anyway due to the possibility of this outcome.  UK stocks have been down as much as -8%, before recovering somewhat towards the end of the session, with banks especially hit.  U.S. equity markets are also down, although to a much lesser degree of about 2.5% mid-morning. (The S&P 500 ended closing down 3.59%, the biggest one-day decline in five years.)Safe haven assets, such as gold, US treasuries and German bonds have rallied, which is the typical response.  In spite of the drop, US stocks are still slightly positive for the quarter..

Now what?  

Yesterday was the equivalent of "I want a divorce,"  and like a divorce, the details of this breakup are unknown until it is finalized in the distant future.  According to Article 50 of the UK bylaws, the process will take a minimum of two years.  This will help mitigate some of the consequences.  New trade agreements will need to be negotiated, which could take even longer.   London is a major global financial center so ramifications for that that sector are a bit uncertain.  The UK, which had been in better economic shape than most other European countries, could see growth suffer in the near-term.  However, a cheaper pound could certainly help British exporters in global trade and tourism, which could offset some of the damage.  This hurts Europe as well, as it loses its second largest member of the union, and one seen as a bastion of stability and a strong economy.  In fact, stock markets in many EU countries fared worse the the British markets.  

Will more members follow?  It’s possible, but there appears to be a lesser chance at this time because other members are much smaller in size, don’t have their own currency, and stand more to lose than they do to gain by exiting. A bigger problem might be the break up of the UK if Scotland and Wales push for their own version of a Brexit from the UK.  
We believe that the Brexit referendum has already changed the trajectory of Europe’s future, putting an end to the idea of a United States of Europe.   We may see an evolution toward a “two-speed Europe,” with those that chose to remain in the euro proceeding toward greater integration and other countries receding back to a looser affiliation with a common market.  The referendum does not undo the NATO military alliance.

What should you do? 

Unless your goals have changed in the past 24 hours, we suggest you simply take a deep breath and stay put.  Or give us a call.  While markets are down and we could see more volatility, this does not look to be a widespread ’08-type panic.  The US economy is much larger and in a stronger position than it was then, and our banks just passed a very rigorous stress test.  There will a period of adjustment while the UK and Europe sort out their differences and re-engage.  During this period, money will continue to flow into the US, viewed as a safe haven.  We wouldn’t be surprised to see relative out-performance by US stock and bond markets and the US dollar.  This will drive down mortgage and other interest rates, the cost of imported goods, and probably energy prices as well.  On the flip side, the higher US dollar makes our exports more expensive.  With a diversified portfolio, some things are going to perform well, while others will not. 

We’ve been through much worse than this, and even greater daily volatility in recent years.   It’s important to remember that investment opportunities generally begin in the times of crisis when other investors are fleeing (aka ‘buy low’).  This reinforces the attractiveness of our valuation-based approached and to opportunities abroad for coming years.  If you have concerns, we would welcome the opportunity to discuss them with you. 

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