We were as surprised as anyone with the results of the Brexit vote. In a historic decision, last Thursday the British people voted to break away from the European Union. Needless to say, this was a huge surprise to the market, the media, and the political class. (As an aside, I think that just goes to show how detached from the pulse of the common citizen the media and political class have become. In fact, this seems to be a reoccurring theme for 2016 – we can see it both in the Brexit vote and the popularity of Donald Trump and Bernie Sanders in the US presidential election.) Today, all the talking heads have been predicting what this means for the UK, Europe, and the world. However, we are convinced that no one knows the exact ramifications yet – there are simply too many unknown variables at work.
However, after considerable research and analysis, there are a few things we can say at this point. First, stepping back for a moment, I think it is important to remember that the Brexit decision is a primarily a political crisis for Europe at this point, not necessarily a financial crisis. It is not like the Greek situation a few years ago, which at its core was a banking crisis. Similarly, it is not like the mortgage fiasco in the US back in 2008, which threatened to bring the financial system to its knees. Brexit is a political issue at this point, and although there is always the potential for that to evolve into a financial crisis over time, we do not see that happening today.
Second, even though the markets have been quite volatile in the last two days, this is not a completely new phenomenon—they were very erratic even in the weeks leading up to the decision. In fact, in the week before the vote, the international markets lost approximately 5 percent. Then in the four trading days before last Friday, they were up approximately 6 percent on anticipation of a vote to “stay” in the EU. When the “leave” vote was subsequently revealed, they turned quickly downward, losing about 10% percent total over the last two trading days. It’s also interesting to note that while the equity markets have captured all the headlines, the biggest reactions have been in the currency markets, where the British pound has fallen against the dollar about 12%. At the end of the day, the markets hate uncertainty, and last week’s vote has created of cloud of political uncertainty that will most likely be a source of volatility and distraction for weeks or even months into the future.
Third, while I do not mean to minimize the political ramifications of last week’s vote, we doubt that it will prove to be a turning point in the economic cycle in the United States. However, there are some important developments from this which will affect our investment portfolios. To start, it seems pretty obvious that we will have a stronger dollar over the short term, as uncertainty surrounding the pound will drive safe haven investors to seek other options. Since we are not primarily an export-driven economy, this should not be a tremendous drag to US growth. Further, it’s widely expected that the global low interest-rate environment will continue as the ECB, Federal Reserve, and Bank of England have all pledged to be ready to provide liquidity should it be necessary. And finally, we will obviously be reevaluating our European exposure given these new political realities to make sure that we are confident in the positions we own.
With all this in mind, as events unfold we will be reviewing and identifying how best to take advantage of the Brexit situation. Volatility usually creates opportunity, and as always we will be looking for those opportunities in the days ahead.