BREXIT! Now What?

We have spent much time this past few weeks digesting what a BREXIT would do to the US Economy, the World Economy and also what type of shock it would cause to the markets.

In our opinion, the United Kingdom’s exit from European Union will have, and has had, a shock affect on the markets.  It will take some time for the emotional mist to clear and give way to logical financial facts that can be used to divine the health of the international economies and related stock markets.  Stock markets are made up of companies and no company will sit idle while the world shifts around them, they will plan and act accordingly.  So, while there will be and has been an immediate shock to the markets around the world (especially since most felt that REMAIN would get the winning votes), calmer heads will prevail in the coming weeks as the UK’s plans with the EU are solidified.  Our sense is that this will effect the UK and Europe to some extent and may even cause some slowdowns or a small short-term contraction in economic growth, but the actual impact on the US economy will be muted.

There is much going on behind the scenes and the rhetoric to make this schism as constructive as possible to allow for a continued strong relationship between the UK and EU.  As the political environment in the UK starts to gel, expect the UK to petition for release under Article 50 of the Lisbon treaty. After that, the exit negotiations will begin followed by, or in tandem with, laying the groundwork for trade agreements and relations with between the EU and the UK.

This is going to be a long process and there is no current crisis.  The companies in the European stock exchanges are not worth 10% less simply due to the vote.  The Euro-zone markets and FTSE will become oversold and then will recover.  Any surprise shock to the system will cause a market reaction.  The US was not immune to this emotional reaction; however, with only a bit more than 4% of US trade going to the UK, the impact on the US economy should be small.  There is no US recession in sight, so our markets should quickly recover.

The bottom line is that you can use this as a buying in opportunity if you like, but at the very least you should stand your ground in your well diversified portfolios.  Enjoy the summer as the fear dissipates and gives way to the reality of corporate earnings, job growth and general slow economic growth in the US and around the world.

Below is a summary of BrExit from our friends at LSA Porfolio Analytics

Brexit
“The People Have Voted and the U.K. Is Out”
June-24-2016

On Thursday, Britain voted to leave the European Union. While this decision is most important for Britain itself, it will also have significant implications for the future of the European Union, exchange rates and global financial markets.

What is ‘Brexit’

Brexit is an abbreviation of “British exit”, which refers to the June 23, 2016 referendum by British voters to exit the European Union. The referendum roiled global markets, including currencies, causing the British pound to fall to its lowest level in decades. Prime Minister David Cameron, who supported the UK remaining in the EU announced he would step down in October.

Market turmoil could create opportunity

This time the opinion polls got it right. The “Remain” and “Leave” camps were running neck-and-neck coming into yesterday’s U.K. referendum on membership of the European Union and in the event some 52% of U.K. voters opted to reject the status quo and pull out.

Markets have responded dramatically. U.K. equity index futures have slumped and the pound sterling has tumbled to 1980s levels. Safe havens such as gold, German Bunds and U.S. Treasuries are seeing substantial investor demand. The euro has also come under pressure.

Fears of ‘Lehman Moment’ Overblown

No doubt this will be the first of many volatile trading sessions, and the major central banks may intervene if necessary. But we caution against reacting as though this were a second “Lehman moment,” as some commentators have suggested.

The likelihood of at least medium-term damage to the U.K. economy from a “Leave” vote, as well as pronounced market volatility on the back of political uncertainty for the U.K. and the EU as a whole, might lead our investors to overreact.  Still, the U.K. has chosen the rockier of two paths. It piles up the political distractions that have dogged the administration of U.K. Prime Minister David Cameron and his chancellor, George Osborne. The “Brexit” camp is clearly in the ascendant but the vote revealed a lack of national consensus. And even consensus would not wish away the complexity of this exit, a “monumental,” multi-year task in the words of one legal expert.

Economic Damage Likely to Be Contained

That complexity is likely to prolong the period of low corporate investment we have seen leading up to the vote, both within the U.K. and in the form of foreign direct investment. This, together with the higher costs of trading, is what led mainstream economists to forecast a 3-7 percentage point negative long-term impact on U.K. GDP.

The pain may not be felt evenly. Many of the large companies in the FTSE 100 Index are global rather than U.K. businesses—80% of the index’s revenues come from overseas. This should help insulate them from any domestic downturn and potentially deliver a windfall from the weakened pound. Smaller, more domestically-focused companies are more vulnerable to a fall in consumer demand and higher import costs. That could be a source of opportunity during a sell-off in U.K. assets, particularly if the U.K. makes its new status work over the longer term.

Elsewhere, the economic impact is likely to be felt most keenly in Europe and, in the words of one Federal Reserve Bank president, to have only “moderate direct effects on the U.S. economy in the near term.” Again, we expect an excessive market reaction to be a potential source of opportunity.

Another Blow for Globalization?

A more pessimistic reading of the vote would see it as one more crack in the edifice of international political and economic co-operation built over the past 70 years. Anti-EU parties in countries like France, Germany and Italy may take heart from the result and attempt to further exploit the euro-skepticism increasingly evident in opinion polls across the Continent.  But to us this merely confirms that globalization is under siege, a trend already well-advanced and understood by financial markets.

 Look Through the Noise to Fundamentals

Most importantly, this vote will probably exert only a marginal effect on global economic fundamentals, which remain stable but weak. We still live in a slow-growth, low-inflation, low-interest rate environment, characterized by sluggish productivity and investment. “Brexit” has been a tail risk stalking markets in the same way that the oil price, the strong dollar and concerns about China created volatility back in January and February, but we think its implications are overstated. For that reason, we again stress the importance of looking through the noise to focus on fundamentals and watching for opportunities to address risk in portfolios. The market reaction may provide opportunities to add to some positions once the worst of the initial volatility has passed.

Looking further out, in a lot of places in the world we still need structural reform and a more appropriate fiscal response to the current malaise if we are going to allow our economies to grow on a proper footing, and our companies to generate sustainable earnings growth. Part of that progress will involve addressing the legitimate concerns of those who have failed to benefit from globalization, but populism and political division is not the way to do it. In that respect, today’s result is hardly good news. But we believe its effect will be marginal and the market’s initial response is likely to create opportunity for patient investors with cool heads.

The impact of traders over the next couple of market sessions will continue to test the soundness of a portfolio’s resilience to withstand volatility.  We continue to monitor the markets and underlying model positions and although our exposures to currency sensitive and European focused positions are light we stand ready to make changes to address downside and risk to portfolios.

 

This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

 

This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.

 

This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.