In an expectedly close but surprising vote, the U.K. has completed a referendum to endorse a withdrawal from the European Union (EU). Today’s market reactions are the usual result from market uncertainty around economic issues—sell-offs in “risk assets" such as stocks and currencies and a flight to quality in “safe-haven” currencies and bonds (e.g. the U.S. dollar and Treasuries). Early analysis of the results indicates, however, that the LONG-term results may not be as severe as feared.
HERE’S WHAT HAPPENED
U.K. and Commonwealth voters, by a slim margin, voted to leave the EU. Prime Minister David Cameron immediately resigned, and a new government will be installed in the fall.
WHAT HAPPENED IN TODAY’S MARKETS?
Stocks and other assets such as currencies, have sold off around the globe. The U.K. and other EU countries have been hard hit, while the U.S. decline has been muted. Leading up to this, the global markets were rebounding over the last couple weeks.
The U.S. dollar and Japanese yen have strengthened; the Euro has declined a bit, and the sterling has substantially declined against the dollar.
There has been a flight to quality in bonds, particularly U.S. Treasury Bonds.
Gold has been priced up, while oil has declined.
WHY WERE MARKETS VOLATILE?
Many believed that Britain would remain in the EU and short-term traders made heavy bets in currencies and other “risk assets.” In fact, markets rallied into the vote as the DJIA was up over 250 points yesterday. Interest rates were moving higher.
The markets were surprised once the votes were tallied and markets reversed their trend, giving back most of these gains. The behavior was violent as Britain leaving the EU is a significant event.
The U.S. markets declined as the thought process that European companies are trading partners of the U.S. This could be negative for some businesses.
WHAT ARE THE LONGER-TERM EFFECTS?
Britain represents 4%-5% of global GDP. Net results may not be that significant.
The U.K. will need to implement policies to provide liquidity and ease interest rates.
The sterling will fall, U.K. inflation will increase due to increased import prices, and U.K. GDP will likely decline in the near-term. A recession is possible in Britain.
The U.S. will be relatively insulated. The Fed will likely delay interest-rate hikes.
Global growth may be affected to some degree. This event is not a ‘Lehman moment’ that accelerated the global Financial Crisis. As one pundit noted, “…markets adapt. Policymakers adjust. Businesses will change course while they continue to seek profits. Prices will reset. Opportunities will emerge.”
WHAT SHOULD BE DONE IN MY PORTFOLIO?
Our principles of portfolio construction are based on each of our client's unique personal goals. Their plan is well thought out and balanced by diversified asset allocation.
Changing your portfolio based on a reaction to market events rarely leads to productive long-term results.
All of our plans are built upon the certainty that we will go through negative events and market fluctuations.
All of our portfolios contain an anchor of high quality bonds and bond funds, which help to limit declines in significant market events, and did so during the Brexit vote today. Our bonds are doing exactly what we want in uncertain times.
We expect short-term stock volatility and will be partially offset by bond and commodities gains. Today’s market moves are short-term reactions, and most currency and bond markets have moved in orderly fashion (i.e. no extreme drops). And, as our pundit notes, “The long-term political, economic and financial repercussions of the ‘Leave’ vote are incalculable at this point.”
While the Brexit vote has been surprising and unsettling, most of the effects will be felt in the U.K. and Europe. We don’t see any required portfolio moves at this point; most of the trading is just that—trading. Long-term investors should stay focused, and we’ll update you as events progress.
As always, if you have any questions or wish to speak to us directly please feel free to call us.
Securities markets around the world have been reacting to the politically charged environment in the U.K. over the fierce debate about whether it should leave the European Union. A so-called “Brexit” referendum vote will be held on Thursday this week. British citizens 18 years of age and older, citizens abroad who have been registered to vote in Britain within the last 15 years, and residents of Britain who are citizens of Ireland or the Commonwealth (53 countries) are eligible to vote.
A vote in favor of leaving the EU would likely trigger further volatility in stock, bond and currency markets around the world. U.S. stocks already proved they were sensitive to the situation in the U.K. when they gapped down at the opening two Fridays ago after a poll conducted by The Independent suggested that 55% of Britons were in favor of a Brexit. The result surprised many investors, and the murder of Minister of Parliament member Jo Cox last week by a man shouting “Britain first!” stunned people around the world.
Candlelight vigil in London for Jo Cox
During the mourning of Minister Cox, tensions eased and additional polls were conducted, many of which suggested that The Independent poll was inaccurate. One betting shop put the odds of the U.K. leaving the EU at just 27%, or about 1 in 4. If accurate, it appears that the conservative groups that support leaving the EU will not have enough votes.
Nonetheless, we find it interesting that the U.K. is dealing with many of the same political issues that are being hotly debated in the U.S. presidential election. Jobs, immigration, and reclaimed sovereignty are the main issues for Britons who favor leaving the EU. These issues are very similar to the “Make America Great Again” slogan of the Trump campaign.
The global boom over the past two decades has eliminated many manufacturing jobs in both the U.K. and U.S. Meanwhile, immigration into both countries has caused concerns for conservative groups ranging from perceived increased competition for domestic jobs to increased healthcare costs and a threat of terrorism. The long-term effects have resulted in rising wealth inequality and chronic under- and unemployment among the middle and lower classes in both nations.
On the flipside, many voters in the U.K. appear to be supportive of remaining in the EU, as do most independent economists and large corporations. If history is an accurate guide, the referendum vote this Thursday could be similar to the last referendum held in 1975, when Britain considered leaving the European Economic Community. Back then tensions were running high as well, but more than 67% voted to remain. That’s an indication of how difficult it is to change the status quo.
Regardless of Britons’ EXPECTED intentions to remain, it’s important to be aware of market risks that could develop this week if the vote goes the other way. U.S. investors are clearly in favor of the U.K. remaining; that’s why U.S. stocks surged on Monday after many news outlets suggested that the votes to remain would significantly outnumber votes to leave. That said, market risk would likely surge if U.K. voters decide to leave the EU. The reason is there are many more unknowns associated with Britain leaving the EU than there are for remaining. Also, risks to GDP in the U.K. and the EU after a vote to leave have been estimated to be as low as a 3.2% decline within the next few years before moderating in the next decade.
In fact, the governor of the Bank of England said the prospect of a Brexit is “the biggest domestic risk to financial stability because, in part, of the issues around uncertainty.”
It has been estimated that negotiations about how the U.K. would divorce from the EU will take up to 2 years. Ironically, some of the most disliked EU economic policies may end up remaining in force in the renegotiated trade and economic treaties with former EU partners.
Some influential business people still believe that leaving the EU is a better option than remaining. Edward Atkin, one of Britain’s most successful manufacturers, was quoted by The New York Times as saying, “Customs duties are completely irrelevant compared to fluctuations of the currency.” Interestingly, most economists believe that a Brexit could be devastating for the pound. They also believe that it would take 10-15 years to recover from leaving the EU.
Regardless of how the referendum turns out, we believe that investors who are diversified in long-term strategies will experience some volatility in their portfolios in the short term. If voters decide to remain in the EU, we wouldn’t be surprised to see stocks around the world enjoy a relief rally. Deutsche Bank provided this handy chart to help illustrate how currencies, interest rates and stocks could respond after the vote.
We are also interested in how this week’s referendum affects the Clinton and Trump campaigns and other conservative movements in Europe. This may be the subject of a follow-up post.