Investment Research Bulletin
UK votes to leave the EU
June 24, 2016
Yesterday’s UK vote in favor of leaving the European Union (EU), after more than four decades of membership, places the global financial markets in a position of heightened uncertainty. There’s no precedent for Britain’s departure, so no one can fully foresee the implications. But, we want to share some key observations with you.
- This is not a Lehman Brothers event. We are not in the midst of a credit crisis. Rather, Great Britain is in a political crisis.
- Although we believe that Britain’s departure from the EU will have negative economic implications for the UK first and foremost, and Europe secondarily, the spillover to the U.S. economy may not be that great. The U.K., which is a fairly small percentage (3.5 – 4%) of global GDP, could see a 1%+ hit to its growth due to the vote to exit the EU. The British economy is currently growing at about 1.5%, so a recession in the UK is certainly not out of the question. The broader EU economy may be impacted by about 0.5%. Here at home, we need to be sensitive to the magnitude of the strength of the dollar. Sustained dollar strength could lower corporate profits for companies with large European exposure moving forward. However, we see a smaller impact on the U.S. economy and do not see a recession.
- The Brexit vote has taken any chance of a Fed rate hike in July off the table. Although we can’t rule out Fed action in September and/or the fourth quarter if domestic economic data is strong, the overall probability of rate hikes in 2016 has fallen significantly. Global economic uncertainty combined with a strong dollar are a recipe for inaction unless domestic data is particularly strong.
- Stock markets around the world are responding to the vote with heavy selling. European markets have been some of the hardest hit, with many markets off high single-digit to low double-digit percentages. Here in the U.S., the S&P 500 is off 3.1% as of this writing. Some of the selling is the result of the negative shock of the exit vote after sentiment had shifted toward a stay result. In the 7 trading sessions prior to the vote results, the S&P 500 had added a little over 2%. We’re seeing a reversal of those gains as well as selling based on concerns over the implications of the exit, both financial and political. Markets hate uncertainty.
- The British vote was a referendum on globalization and immigration, issues that have been fueling populist movements around the globe. We need to monitor whether similar sentiments manifest themselves in stronger exit moves in other European countries and in enhanced Trump support here in the U.S.
- We advise against taking any immediate action into the volatility that we’re seeing today. Emotion often rules the markets when faced with the type of unexpected event that we saw overnight. Stocks are not highly overvalued but they’re not cheap either. On the negative side, uncertainty will reign for an extended period as the UK negotiates its exit. On the positive side, the “back to the U.S. theme” that we’ve seen for some time should remain strong.
- In our original Outlook piece for 2016, we wrote about our “de-risk your portfolio” thesis, given our expectation of very low stock returns this year – not negative returns but very muted, single-digit returns. We continue to believe in this thesis and would use periods of strength to lighten up on equity allocations. Although we do not see significant downside in stocks from current levels, we feel risks have risen over the past two months.
Please reach out to us if you have questions regarding the implications of Brexit or the market in general.
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