BREXIT : TALKING POINTS
June 25, 2016
Here we go again… Yet another historic feeding of the beast! This time the beast is known as “Brexit”. The United Kingdom (UK) voted to leave the European Union, in a referendum with 52% support for a “Brexit” and nearly 75% voter participation. Prime Minister David Cameron said he will resign before October when his party picks a new leader.
All of this creates a lot of uncertainty. Nobody knows what will happen or when, which often prompts the markets to retreat to perceived safety. The fog of confusion will most likely persist: The terms of exit will be negotiated among the EU’s 27 members, each of which will have a veto. European legislation provides a period of up to two years for the “divorce” to get settled.
What does this mean for investors? In these talking points, I put aside politics, review the situation, its effect on investment markets, and how it may affect your portfolio. In general, as long-term, value investors, we aren’t moved by these market disruptions, which usually are temporary. Instead we view these situations as a chance to buy assets we like at lower prices.
What are the risks?
First and foremost, a Brexit would likely mean the UK would lose the passport rights for the financial industry, a mainstay of the British economy. This would make it harder for UK financial companies to do business in Europe. Most likely, treaties will be negotiated to keep business running as usual, but we don’t know on what terms as it will most likely depend on the political climate.
S
econd, trade agreements will have to be negotiated anew, not just with the EU, but with other parties with whom the EU has trade deals. There are alternatives, but generally speaking, there s a politics-economics trade-off: The less these agreements bind the UK, the less beneficial they will be from a free-trade standpoint.
The Brexit might redraw political boundaries as well, both in the UK and in the EU. Scotland and Northern Ireland are firm supporters of EU membership—as reflected in their vote yesterday. Both have also questioned, at different points in time, whether they should remain in the United Kingdom – meaning that the Brexit may give a second wind to secessionists.
For the EU, Britain’s vote proves that European membership is reversible. The situation here then becomes that other countries might head for the exit as well. Euroscepticism is particularly high, according to polls, in Greece and France. Leaving Europe, however, would be a lot harder for countries that have adopted the euro than for the UK. Even if no other countries leave, the Brexit might slow down the process of EU integration.
Markets Implications
The news of the Brexit vote hit currency markets the hardest. The British pound fell 8.3% against the U.S. dollar Friday morning to its lowest level since the mid-1980s. Meanwhile, the U.S. dollar appreciated against most major currencies, reducing the value of international assets to U.S. investors. European financials stocks sold off more than 10% as increased regulatory uncertainty of the European financial system weighed on share prices. In the U.S., the S&P 500 dipped 2.8%, while the 10-year U.S. treasury yield dropped sharply to 1.55%, reaching its lowest level since 2012. Source: Bloomberg
Portfolio Implications
Major selloffs often spur a variety of responses by investors. Initially, many become consumed by media accounts of the specific causes, with the negative implications reinforced by the losses in the market. Often that leads to a fear-based response to sell after markets are down in an attempt to avoid future losses. This typically only locks in the current loss and prevents the investor from benefitting from future market gains.
I believe in selecting funds and managers that make every effort to resist emotional responses and focus their efforts on finding assets that are inexpensive relative to their intrinsic values. I find that the best opportunities for future gains often come when markets overreact to news and forget that in the long term, prices reflect the future cash flows a security generates. With equities, stock prices should move based on changes in the long-term earnings power of the company.
In that spirit, I think that the selloff driven by the Brexit vote has the potential to create opportunities for our portfolios in cases where prices have moved away from underlying value. I see less opportunity in long-term government bonds that rallied on weakness in stock markets and our managers are evaluating the hardest hit parts of the market looking for areas that have been unfairly beaten down.
What Does It Mean?
It means we’re in for period of market turmoil and increased volatility in the short run, and higher levels of protracted global economic uncertainty in the mid-term.
So Now What?
We (you and us and our strategic partners) recognize and acknowledge the distinction between what is and what is not in our control.
We sit, we watch, we analyze. We patiently wait to reposition as we gain understanding and work to attain quantifiable, actionable data.
We don’t get sucked into the emotional vortex, nor do we react to or participate in the turmoil.
For we are investors, not traders… And we are ZeroCelsius. Right on.
Enjoy your week,
Ross
This commentary may contains certain forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.
The opinions expressed herein are those of ZeroCelsius Wealth Studio, and are not necessarily those of our strategic partners, are as of the date written, and are subject to change without notice, are provided soley for informatonal purposes and do not constiture investment advice. Except as otherwise required by law, ZeroCelsius Wealth Studio shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use.
There, I said it.