This week’s blog topic was a pretty obvious choice. The United Kingdom made a disappointing exit from Europe in the last week, and I’m not just talking about their epic upset in the 2016 Euro Cup at the hands of Iceland.
Brexit, in short, was a referendum on whether or not the citizens of the United Kingdom wanted to remain in the European Union or not. Last Thursday’s vote wound up, somewhat surprisingly, with 52% of voters in favor of leaving the union.
I want to use this time to be as helpful to our clients and readers as possible. There’s no need to rehash every detail of what’s occurred. There’s no shortage of news out there on what has actually happened.
For one of the better breakdowns on those details, check out the BBC’s “All You Need to Know” page. For up to the minute news on the saga as it unfolds in England and throughout Europe, coverage from British daily newspaper The Guardian is tough to beat.
In the days since, markets have been roiling in the U.S. and abroad. The Dow Jones Industrial Average, which was up more than 220 points the day of the vote, dropped more than 600 points on Friday and more than 200 again on Monday.
What happens next is impossible to say, but if you do want a snapshot as to some possible scenarios, the Wall Street Journal published a graphic laying out several possible scenarios (link may require subscription).
This is not a call to ignore the news and keep moving forward. What happened last week could have long lasting effects on globalization, the makeup of the United Kingdom, the stability of the European Union and a number of other potentially significant issues.
That said, it is important to step back, take a breath and assess what we know and what some of the likely outcomes are to determine the best path forward.
Where things were last week
Ahead of last Thursday’s vote, the markets not only thought a Brexit vote was unlikely, the rest of the world markets were thriving. Many asset classes were at year to date highs, some near all-time records. The International Real Estate fund we use in our portfolios was up more than 14% for the year with Emerging Markets Value not far behind up nearly 11%. The worst performing asset class for the year, large international companies, had turned back to positive as the global economy seemed to be showing some signs of resolve and the U.S. was seemingly running on all cylinders.
Where things currently stand
Since then, things have reversed course in relatively short order. As of Monday evening, Emerging Markets Value and International Real Estate funds are now up just over 4% for the year. U.S. companies large and small have ticked slightly negative and large international companies have retreated strongly, down a little more than 10% for 2016.
Where things might be going
It’s tough, but getting caught up in a few days of volatile trading can be dangerous to the long-term investor. Instead, we should look at the broad market reaction to an unexpected event and assess best and worst case scenarios and the potential impact to markets.
First, it’s important to remind ourselves that nothing has actually happened yet. This referendum was an indication from the British people of how they’d like their government to act. For the U.K. to leave the E.U., they must notify the Union that they wish to invoke Article 50 of the Lisbon Treaty which starts a two-year clock on negotiating trade deals, immigration policy, debts owed and a myriad of other factors that would allow Britain to leave.
Prime Minister David Cameron announced almost immediately that he would resign within the next three months and would count on the newly elected Prime Minister to take these actions. This would mean, in short, that things would remain largely as-is for a minimum of 27 months.
Potential worst case scenarios include break downs in a multitude of trade deals, contagion spreading to other countries wanting to leave the Union and even greater uncertainty and risk in markets for many years to come.
The U.K. itself could break up. Sinn Fein has already announced their desire to leave the U.K. and rejoin Ireland in remaining in the E.U. Scotland has suggested they might revisit their 2014 independence referendum as they voted overwhelmingly to remain in the E.U. last week. The British pound dropped to historic lows and Standard & Poor’s has reduced their credit rating.
There are rosier scenarios, too. Some are already calling for a “do-over” or a re-vote. That seems unlikely, though public opinion seems to have swayed dramatically since people started fully getting their heads around the impact. A more likely scenario is that electing a new Prime Minister will, in effect, become a second referendum. If a pro-Brexit leader is elected, exit talks will likely progress. If not, the new minister or Parliament could opt not to invoke Article 50.
Even if the exit does move forward, it is possible that all sides will see the benefit in keeping things as civil as possible and allow for the political process to leave many of the same trade agreements and arrangements in place that other non-Union European nations, such as Norway, have enjoyed for many years.
What to do
The bottom line is that this was a shock to many of us and certainly to markets across the globe. Uncertain shocks lead to market volatility. Whether best case, worst case or somewhere in between, it is unlikely that this will fully resolve itself quickly. Each step in the process is likely to cause jitters in the market followed by a smoothing out as investors digest the impact of each step. We’ve seen this already. After two punishing days that nearly wiped out all gains for the year, markets are bouncing back somewhat on Tuesday as I’m writing.
We’ve seen these kind of reactions recently with turmoil in Greece, Egypt, China and even here in our own country. We’ve also seen them with all sorts of global crises throughout the history of the market. Looking forward, we still have an election of our own in just over four months that could cause some short-term instability.
In our client portfolios, we’ll use these ups and downs to take advantage of rebalancing opportunities as the market dictates, taking profits from those asset classes that outperform and investing in those that are struggling on the latest news. Over the long run, this is the only method that has withstood all storms and provided a successful experience for investors in virtually any market.
If you’d like to talk about this or any other issues with us, don’t hesitate to reach out and ask. We’ll be covering this and more in future meetings as well.
Thanks for taking the time to read the blog and we hope all of you have a very safe and Happy 4th of July!!