Due to the volatility of almost all markets over the last few days, I want to share our thoughts on the British exit (or “Brexit”) from the European Union (EU). As is well known now, the result of the referendum last Thursday, June 23, was a slim victory in favor of Britain leaving the EU.
In the days preceding the vote, the S&P 500 and other equity markets rallied as Brexit fears faded. The unexpected referendum results paired with uncertainty as to how this resolves led to declines of over 5% for the S&P 500 in the last two trading days; most other equity markets have declined even further.
Touching on all the details and potential implications of Brexit would require an extremely long commentary and would quickly get into a lot of information most of you are probably not interested in. And as our aim is to relay information to clients quickly, I am summarizing what I believe to be some of the key points:
- Brexit is a great story for the financial media to write about, prognosticate about and worry about. It may even turn into a political crisis. The likelihood of it becoming a financial crisis does not appear that great at present.
- A 2008 liquidity & banking type crises does not appear to be a concern at this point due to:
- Credit (fixed income) markets presently do not suggest systematic risks.
- There is a lot of liquidity around the world and a good chance further steps will be taken to increase liquidity.
- Banks are generally much better off than they were in the European monetary crisis and during the crisis in the US following the real estate bubble.
- Given the market’s disdain for uncertainty, I expect volatility to remain high in the near term. This does not necessarily mean further market declines.
- A major question is how the UK practically exits the EU (which I assume will happen at this point but is not guaranteed). This will take years to fully resolve. My hope is that the UK ends up in a similar position as Norway & Switzerland in that the UK & EU work out free trade agreements; but this will be arduous process to work through.
- The UK economy will most likely suffer, or not grow as much as expected, over the next couple years. This will not necessarily be the case in the U.S. and remainder of the EU. Economic growth in the U.S. is primarily driven by U.S. consumer spending, and corporate exports to the UK are fairly small as a percentage of total exports. The EU consumes a high percentage of exported goods from the UK, but the reverse is not the case – EU exports to the UK are a fairly small percentage of total exports.
- Currency valuations have already shifted and will continue to be an underlying story. A strong U.S. dollar, which is a likely outcome of Brexit, may decrease U.S. corporate exports. As of this writing, the dollar is near a 30-year high versus the British Pound (around $1.32 per Pound). The dollar has slightly strengthened versus the Euro in the last few days, and I would expect current levels to hold or the dollar to further strengthen due to uncertainty in the EU. Good news side note: If you’ve been eyeing a pricey European product or a trip to London, Rome, Paris, etc., this may be a great time to make it happen given the dollar strength!
- Some issues we’ll watch going forward:
- Whether or not the EU takes a retaliatory stance toward the UK.
- Whether other countries in the EU indicate interest in following the UK’s lead of exiting the EU.
- Whether free trade generally continues or is diminished through trading barriers and restrictions.
We will of course continue to monitor the Brexit results and implications, but at this point, we do not anticipate making any major changes to our portfolio allocations. We continue to believe that the best course of action for all investors is to create a long term financial plan, make well thought out adjustments based on life circumstances and estimated chances of reaching the goals defined in a plan, and to ignore the temptation to make investment decisions based solely on short-term market movements.
If you have any further questions regarding Brexit or have any concerns not addressed in this commentary, please feel free to contact me by phone or email.
Marshall Bolden, CFA
Vice President, Chief Investment Officer