Contrary to what many establishment elites assumed, The United Kingdom voted to leave the European Union in a historic vote on Thursday, June 23. Heading into last Wednesday, the polls were running about even for staying (Bremain) and leaving (Brexit). The final voting tally was 52 percent to 48 percent, and the out-of-touch “establishment elites" are stupefied by the referendum by British voters to leave the E.U.
Markets reacted in dramatic fashion as many investors were caught wrong-footed by the Brexit win, and by the closing bell on Friday, the Dow Jones Industrials had lost over 600 points. The S & P just dropped below its 200-day moving average as of the writing of this piece at 10:15 a.m., Monday, June 27 - an ominous trading sign. Safe haven assets, such as gold and U.S. Treasuries have rallied in typical response to a perceived negative market event.
- This is not a 2008-type crisis. We could be heading for a prolonged period of ambiguity as markets sort through the U.K.’s “divorce details” from Europe. We could experience continued bouts of volatility in the weeks ahead, particularly in currency markets.
- The tip of the iceberg? The Brexit trend could have a “domino effect” elsewhere in the world. Voters everywhere have grown increasingly disenchanted with the outcomes of globalization over the past 25 years. Note: next year, France and Germany head to the polls. If "de-globalization" sentiment continues to build, the effects could be significant for the future of the European Union and elsewhere.
- Politically, it’s not over: The U.K. government is in turmoil as Prime Minister Cameron has announced his resignation effective in October. It will be up to the new PM to trigger Article 50 of the Lisbon Treaty and begin the two-year process of negotiating the U.K.’s exit from the EU and new trade deals.
Why Brexit now?
There has been a growing populist political movement in the U.K. (as well as in the U.S.), fueled by British middle-class concern over their future due to lax immigration rules and an open-border policy between EU members. The rise of ISIS and recent horrific terrorist attacks have served to fuel voter angst. The Brits evidently have had “enough of experts.” Globalization didn’t work out as well as promised; middle-class citizens have watched their wages remain stagnant for decades.
What happens next?
As mentioned above, Prime Minister Cameron, who backed the “Bremain Camp,” has made it clear that the decision to trigger the U.K. divorce with Europe under Article 50 of the Lisbon treaty is for his successor. Many believe the new prime minister will be Boris Johnson, former mayor of London and a chief “leave campaigner.” The new PM will begin the negotiation of new trade agreements with Europe in October, and it could get contentious. The rest of Europe is none too excited about losing one of EU’s largest members.
Between now and October, there is a leadership vacuum that will likely result in continued political turmoil in the U.K. It remains to be seen if the U.K. anti-establishment vote has a “domino effect” elsewhere, particularly here at home in our presidential race. Our equivalent to Boris Johnson, some might say, is Donald Trump. Additionally, given the lack of clarity surrounding Brexit details, business investment spending (capex) is likely to remain on hold, furthering the probability of a recession in the U.K.
The Brexit still needs to be approved by the majority of the remaining European Union members in October. Just as with any divorce, there is going to be a period of adjustment as both sides work out their differences.
The U.K. is one of the largest economies in the world, and London is a key global financial center. As such, investors are understandably concerned. However, I believe expert economists who are promulgating dire global market consequences from the Brexit are simply wrong. Keep in mind, the European continent has been in a prolonged recession since the U.S. triggered a financial crisis in 2008, with the U.K. being in the best financial shape of the group. While the Brexit hurts European growth in the near term, the U.K. could benefit from better re-negotiated trade deals. A cheaper pound will certainly help U.K. exporters in global trade, offsetting some of the economic damage from the Brexit.
Markets will continue to be choppy as Brexit angst weighs on investor sentiment. Many banks and money managers will be forced to liquidate holdings to meet redemptions and reduce risk. However, this does not appear to be an '08 - caliber panic event. Central banks have made it clear that they stand ready to intervene and provide liquidity to markets. It’s now likely that the Bank of England will cut rates in July and rate changes by our Fed will remain on hold until after the November elections. From a credit perspective, the ratings agencies have announced that the UK’s sovereign debt will be downgraded as a result of the decision to breakup with Europe. And downgrades could widen credit spreads.
Our bottom line:
During market corrections, it’s important to remain calm and keep in mind that investment opportunities are borne out of market uncertainty and panic. A post-Brexit backdrop will create some fallout in markets along with inefficiencies, creating opportunity in high-quality U.K. equities, bonds and other global asset classes. U.K. businesses have been hit hard here, and some of the impacts of the Brexit vote may already be reflected in prices.
This is the type of environment where "best-in-class" long-term asset managers would be expected to add value by seeking out undervalued assets. At Cambridge Wealth Management, we will continue to look for opportunities where assets have become attractively priced due to market dislocation. However, we’re not rushing to purchase any assets, as we remain mindful of the challenges in the near–term. Public sentiment and geopolitics are ever shifting, but great leaders and businesses always seem to find a way to adapt quickly and prosper!
Sources: The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes.com; The Economist.com; MFS research; Fidelity research; CNBCNews.com.
Observations and views expressed herein may be changed at any time without notice and should not be construed as investment advice or to predict future performance. It is not an offer, recommendation or solicitation to buy or sell. It is based on information generally available to the public from sources believed to be reliable. Changes to assumptions may have a material impact on any returns detailed. Past performance is not an indication of future returns. Please consult your financial professional before making an investment decision.