The Brexit Vote
Friday, June 24, 2016
Last night, voters in the United Kingdom (“UK”) decided to leave the European Union (“EU”). The so-called Brexit was viewed as “inconceivable” by most pundits, politicians, betting parlors, and the markets. Apparently, none of these people had ever seen The Princess Bride, and kept using that word without knowing what it meant. The view that this event was so unlikely is roiling global markets today, especially currencies and equities.
Here’s what our clients need to know:
Why did the UK want to leave? There are a host of reasons cited, though most revolve around wanting more sovereignty, relief from EU regulations and the financial burden of supporting other weaker EU members, and concerns over the effects of immigration on the UK labor market, i.e., low cost immigrants taking jobs from Britons.
What happens next? No one knows exactly. The UK was not a full-fledged EU member; it has its own currency and central bank, though it was part of the EU in terms of trade and free movement of capital, goods, and people. Seven of the UK’s top ten trade partners are Euro currency countries, and trade agreements with remaining EU members will have to be renegotiated. The concern markets have is that the EU will make an example of the UK to prevent the other “real” members of the EU, i.e., those that use the Euro currency, from contemplating a divorce.
Why are the markets reacting so negatively this morning? In a word, uncertainty. Economists are predicting the UK’s departure will lower its GDP as well as that of the EU, which is moving both the GB Pound and the Euro lower versus the dollar, with the Pound hitting a 30 year low. Brexit has also prompted sharp sell-offs in global equities. Ironically, UK stocks are down less than other European markets at present. Domestically, equity futures are lower by a few percent while yields on US Treasuries are lower as investors seek safety in US government bonds.
What effect will this have on the US economy? As we saw in the above graph, the US is the UK’s second largest trading partner. A trade agreement between the two has been in the works, but hung up in EU bureaucracy for some time. The ultimate effect is unknown, though US exports may become more expensive as the Pound and Euro weaken, and could be hurt by the expected economic contraction in the UK and the EU. The most direct impact may be on US multinationals that use the UK as their nexus to trade in the EU’s markets. These companies will face uncertainty until more is known on how trade agreements will be renegotiated.
What should I do with my portfolio? We could be in for a volatile summer as this saga unfolds, not to mention a US election on the horizon. Spanish voters go to the polls Sunday, and could continue the burgeoning populist tide by electing upstart, anti-establishment parties. Currently, our international equity weighting in client portfolios is intentionally lower than many of our peers or the prominent target date funds. Furthermore, we have no exposure to developed European bonds. Ultimately, we are believers in diversification and staying the course, and in the event of a stock market correction, we would re-balance portfolios back to long-term target levels. The best advice we can give clients comes from a slogan popularized in a UK propaganda poster from World War II: “Keep Calm and Carry On”.
- The Opus Wealth Management Team
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