June 27, 2016. By John Wolfsberg:
Last Friday, the United Kingdom (UK) electorate voted to exit the European Union (EU), surprising financial markets which had rallied risk assets in the week prior in anticipation of a win by the “Remain” camp. With the volume of commentary and coverage on this historic decision, we want to offer our thoughts on the potential implications for investors in the short term.
It’s universally accepted that the?nemesis?of the capital markets is uncertainty, and Thursday’s vote served up one of the largest doses of uncertainty in quite some time. No one knows for sure what impact a “Brexit” will have on the UK, European or Global economies, or how an independent UK might look and what impact a departing member may have to the remaining EU. Accordingly, investors’ response has been to sell first and figure things out later.
Some of this selling was a natural correction to the rally in risk assets that occurred in the middle of last week – these assets rallied as financial market were sure the “Remain” camp would win the upcoming referendum. When this optimism was shown to be misplaced, the “risk off” trade ensued.
While the risks and implications?regarding?Britain’s vote are varied and complex we think the following represents some of the more material?concerns;
- Contagion, the risk or?likelihood?of other countries following suit and by?extension the?undoing?of the EU as we’ve known it for the last 43 years.?Already, Brexit has encouraged anti-EU factions within other countries to clamor for their own referendums.
- Trade, as further defections have the possibility of rendering the many trade, tariff and cooperation agreements among EU members and global trading partners null and void. Trade between countries could become?complex and expensive, where countries and companies need to navigate many disparate policies and statutes in order to do business.
- Currency weakness and the implications associated with weaker currencies,?especially?as it relates to the UK and remaining?EU members. The severe decline of the British Pound and Euro?against the US dollar in just one day was extreme, with the Pound?dropping over 8% vs. the US Dollar. Overnight US goods became 8% more expensive to buyers in the UK and almost as much across the region’s other trading partners. ?For some of the largest?US companies who derive a?material amount of their revenue and earnings overseas the downward?earnings revisions are already in progress.
Any attempt to fully quantify the ramifications of last week’s event?is, in our mind, purely speculative at this point. Instincts and history suggest that the?heightened?uncertainty and?volatility is generally bad for equities in the short term?given that many?sectors?of the global economy are already starved for growth. That said, we do believe that the US economy is on solid footing and is in a position to withstand the economic impact of this event. In addition, we expect central banks (both in the US and abroad) to provide the necessary support to stabilize financial market should the need arise.
We are in the very early stages of what some have termed a “watershed event” and therefore are in need (as managers and investors) of more information before making an informed decision with regard to investing.
It should be noted that the whole process of an exit will take some time. The process is governed by Article 50 of the Lisbon Treaty which provides for a two-year period for negotiations of terms to be held between departing members and the EU.
We will provide more commentary internally as well as from respected?third?parties?in the weeks to come.