Brexit
Late yesterday, the United Kingdom voted to leave the European Union. Global financial markets had rallied earlier in the week on hopes that the British would vote “Remain” and thus provide more certainty to the future of the EU. As a result of the vote, global markets are sharply lower today. We offer the following observations and recommendations:
- Overall economic growth will likely be somewhat lower, with early estimates showing a 0.5% impact to global real Gross Domestic Product (GDP), as the disruptions from Brexit impact businesses, especially in the UK and in the Eurozone. The US economy will be less affected, as it conducts less trade with both entities.
- Fears of a global recession are likely overstated, similar to the January growth scare, which was prompted by the volatility of China and oil at the time. Both stabilized, eventually leading to a rally in equity markets.
- Major central banks are vigilant, and have already signaled willingness to provide adequate liquidity to lenders and other companies. Also, central banks have not run out of policy tools, as pessimists have contended. This last point will be expanded upon in our next market commentary, coming out early next month.
- The Brexit will likely take time to fully execute, with most economists estimating at least two years. While introducing uncertainty, the protracted timeframe will likely reduce any massive dislocations, both in the UK and in the EU.
- Brexit does introduce the possibility that more EU members may leave; however, the remaining European nations use the Euro as their currency, causing great complications if they would want to leave. The UK, on the other hand, has always used the Pound as their currency, making a divorce with the EU much easier to accomplish.
- The financial industry, especially in the US, is in much better condition that it was in 2008. Preliminary results from the latest “stress tests” show that the major banks have more than adequate capital in case of a major economic downturn or event, such as Lehman Brothers. A repeat of a financial crisis similar to that period is extremely unlikely.
- The longer term issue is really more of a political, rather than a financial nature. The major reason for the “Leave” vote was a concern over unbridled immigration and a loss in sovereignty. This message reverberates both on the Continent and in the US as well.
- The latest developments further postpone any Fed tightening, which should help stabilize the markets. There is now a significant chance of no Fed rate hikes this year.
- The trading range for the S&P 500 is still in place. As on numerous occasions over the past two years, selloffs have provided buying, rather than selling opportunities.
- Our portfolios are well diversified with numerous asset classes, including low correlation categories such as gold that offer a cushion against market selloffs. Additionally, the equity portion of portfolios is slanted towards defensive companies with most of their revenues in North America, especially in the US.
We recommend resisting the temptation to emotionally sell in this situation. Warren Buffett has commented repeatedly that it has been foolish to vote against the US and the American economy for the last 240 years, and it remains so. We agree, and still believe that the US is still in a long-term bull market in stocks, though the periodic episodes of volatility will continue.