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.