Brexit It Is


Since the fall of 2015, we’ve been anticipating volatility leading up to the June 23rd vote by the U.K. on whether to remain a part of the European Union, repeating this mantra even when markets experienced what seemed like an irrational fall in January of this year, seemingly in response to volatility in Chinese stock markets and a falling price of oil.   Sure enough, markets recovered quite quickly from the January fall, with oil stabilizing at more normalized levels and attention shifting away from the sensationalism of a relatively unimportant Chinese stock market.

June arrived somewhat quietly in a market that was quite tame; somewhat surprisingly to us, volatility really didn’t see any significant increase and markets remained relatively stable in advance of the Brexit vote.  In fact, the Dow Jones Industrial Average was up about 500 points in the five trading days leading up to the Brexit vote, signaling a gamble by some that the UK would vote to remain a part of the EU.

As London woke about the time we should have been going to sleep, approximately 52% of voters in the UK elected to vote in favor of the referendum to leave the EU.  Many in the EU, and in the UK, expressed shock in the wake of such a vote.  Financial markets reacted viscerally, with the UK perhaps suffering the greatest.  The British pound saw its biggest decline in history, falling to lows not seen in more than 30 years.  Assuming weakness remains in the pound, inflation is likely to surge in the UK, and living standards will fall.  It’s estimated that the prices of UK real estate may fall by 20% or more almost immediately with demand falling significantly given the uncertainty.  S&P has communicated for quite some time that in the event of a Brexit, the UK would very likely lose its AAA credit rating.  It causes one to wonder whether those who voted in favor of leaving the EU really understood the ramifications of such a vote.

 

Certain Uncertainty

One of the biggest impacts of this historic vote is the creation of uncertainty.  Although the result of the Brexit vote was 52% in favor of leaving, with less than 100% turnout it’s an estimated 35% of the electorate who voted to exit.  It is quite likely the UK will actually proceed to invoke Article 50 and begin the formal procedure of exiting the EU, but when will such invocation take place?  That invocation is many months away, and during the estimated two year process of negotiating new trade and other formal treaties with the EU, there will remain great uncertainty for businesses wishing to engage in trade in the region, which may very well depress investment and economic activity.

Perhaps the greatest uncertainty surrounds the future of the European Union itself and what actions other countries may take in the wake of the Brexit.  Will the Brexit ignite populist and nationalistic viewpoints leading to Italy, France, Denmark or others issuing a referendum to leave the EU?  More dramatically, does a Brexit spell the beginning of the end of the EU?  On the flip side, with Scotland having voted overwhelmingly in the UK referendum to remain in the EU, and having voted a short two years ago to remain a part of the UK because of the UK’s EU membership, will Scotland issue a referendum to leave the UK?  Only time will provide an answer to these questions, although trade relationships will no doubt remain an important part of European relationships.

Of course, there are serious concerns regarding the UK’s economy now as well.  The EU is the UK’s largest trading partner, with about half of their exports going to EU countries.  Those exports accounted for roughly 13% of UK GDP in 2014.  Furthermore, many of those exports are in the form of services, such as finance and insurance, which benefited from access to EU markets without having to meet regulatory requirements at the individual country level.  And while a member, the UK enjoyed trade agreements with over 50 other economies, which will now likely require renegotiation.  In short, it’s not unreasonable to expect that a prolonged UK exit and negotiation process will create drags on both British exports and overall economic growth.

 

Stock Market Reactions

Stock market trading in Asia and Europe was tremendously volatile, with buyers understandably hesitant to dip their toes in amidst the chaos.  The Japanese Nikkei index fell about 8% and the Stoxx Europe index opened down about the same, with very large spreads between bid and ask prices amid heavy selling.

As we write this in the early morning hours of June 24th, there is little doubt that the US stock market will experience a negative reaction to the events of the evening, and the volatility we had expected in advance of this vote will arrive all at once in an uncomfortable dose.  The futures markets predicted a US stock market open of down 3.5-4.5%.  While such a move is discomforting, it’s worth recognizing that this is a move that rewinds markets merely to February or March of this year, pulling back from near record highs.

 

What About My Portfolio?

It’s important to keep in mind that the initial stock market moves in response to events such as this are generally knee jerk reactions that are overdone.  While we expect an initial negative stock market reaction to a Brexit, it’s important to remember the fact remains that, despite the egos of many who endeavor to convince us otherwise, nobody can predict the direction of the stock market, how far up or down it will go, or when a bottom or top has been hit.

The above being the case, we remain committed to a disciplined approach to stewarding client portfolios utilizing a balanced approach that offers downside protection in addition to upside opportunity.  Of course, we cannot predict the timing of any moves the market might experience, but we are confident that any downturn in the stock market will prove to be a buying opportunity, that companies will adapt to new challenges and opportunities, and that cooler heads will eventually prevail.

If you find yourself concerned, we are more than happy to talk with you about your allocation and whether it remains prudent given your situation and financial goals. Although it’s a broad generalization, if this vote to leave is the only variable that’s changed in the calculation, it’s also fair statement to make that this now is not the time be selling stocks.

On a personal note, our hearts cannot help to go out to the citizens of the UK this morning.  They are now facing crises on multiple fronts… socio-economic, political, and cultural.  Indeed, an Englishman or Scot or Irishman or Welshman this morning could be easily forgiven for having fears regarding the future existence of their very country, at least as they’ve known it for the last 70 years.  To them, it is nothing less than a seismic event, and even here we can feel the earth shake.

The best thing that we can do, in our view, is keep them in our prayers, Keep Calm and Carry On.

 

In Other News…

Likely to be overshadowed by the Brexit vote, all 33 of the largest US banks passed their annual “stress test” signifying all have sufficient capital to survive a financial crisis such as that experienced in 2008.  The US economy is on relatively stable footing with unemployment at very low rates.  While the financial markets are likely to experience some short term volatility, we encourage you to not allow such volatility to impact you emotionally.  School is out, the baseball season is in full swing, and it being June 24th, Barry’s son Carter celebrates his 11th birthday today.

While the results of the UK vote are shocking, life goes on.  We encourage you to turn off the financial news and ignore the sensationalistic headlines, focusing on things that are truly important in life, as this too shall pass.  As always, please be in touch if you’d like to chat about your specific situation.

God Save the Queen.


A little more about Capital Financial Planners...

Established in 1984, Capital Financial Planners, LLC is an independent, fee-based investment management and financial planning firm located in Salem, Oregon. We provide wealth management and advisory services to clients in the Pacific Northwest and beyond. Our services include retirement planning, investment management, advisory services for trustees, hourly financial planning and more. We take a holistic and collaborative approach, working not only as our clients’ financial advisors, but as their financial partners.


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