Special Report: Brexit

By David B. Armstrong, CFA | Jun 24, 2016 | Weekly Market Commentary

Well it’s a good thing I signed off my weekly blog about Brexit with this:

What does it mean for U.S. investors?

No one has any idea…and that’s a problem for short-term focused investors. It’s really not a “play-able” event, since you have to guess what is going to happen.

After a few nice up days on the back of speculation that Britain would remain, they surprised everyone as polling data started trickling in and America settled in to watch a new episode of Big Brother on TV.

The final count?

51.9% to exit the EU.

OUCH

UK Prime Minister David Cameron, who opposed Brexit, announced he would step down.

The vote is technically a “nonbinding referendum,” which is a fancy-schmansy way of saying Parliament could simply blow it off, so the referendum has no legal standing. It is possible that a new government could order a new vote.

I don’t think blowing it off is likely. A new vote? Ehhh, not likely either. But still, both are technically possible.

All this is to say that now is not a time to panic. Not today, not over the weekend, not Monday morning and not even next Friday….why?

1. I don’t think that the companies that make up any of the markets selling off today are worth 4-9% less today than yesterday.
2. It could literally be months before the UK formally requests a separation from the European Union.
3. The repercussions of this vote will probably take 5 at least years to play out.
4. There will be compromises and consultative dialogue that takes place in order to ensure that as little of this as possible is detrimental to Britain and the remaining EU partner countries.

So What’s Happening?

Government bonds in the U.S. and the stronger European countries are rallying, and gold is up, too. The British pound is down around -7% while the euro is down a more modest -2.5% (as of this typing).

U.S. stocks are down over 3% in fairly orderly trading (unlike last August). Prior to the market’s open, the Dow futures were down over 700 points.

Let’s see how today ends up and then we can see how everyone digests the information over the weekend. Most people in my industry go home on Friday with a huge stack of printed research and read it all over the weekend. That could impact Monday’s markets. CNBC has been reporting that today is the annual rebalancing of the Russell indexes – this will cause some increased volume as we get towards the close.

Looking Ahead

Despite my last name, “Armstrong,” I’m not smart on the whole Scotland / Northern Ireland situation but I don’t think they wanted to leave the EU. It was only two years ago that fear of economic uncertainty encouraged voters in Scotland to remain in the UK. I read that the Scottish First Minister Nicola Sturgeon said that a new Scottish referendum on independence from England was “highly likely” following the referendum. Northern Ireland may choose to do something similar.

I don’t think that’s going to be helpful to the situation, but again, I’m not well read on that topic. I do like that Netflix show “Peaky Blinders” though.

That leaves us with how this will (eventually) impact the eurozone, and/or the 19 nations that share the euro as its common currency.

Like anything unexpected, it adds a volatility and an additional level of uncertainty in the financial market, BUT, I don’t see how this creates any sort of a “Lehman moment” that agitates the credit markets. As I mentioned above, Britain must compromise, negotiate and renegotiate existing trade agreements with the rest of Europe and major countries like…well…the U.S.

I’m telling ya, this is probably going to be a slow and tortuous process. You thought watching Greece play out was torture? Just you wait!

Conclusion

To summarize, this vote has injected a new level of doubt into the global markets, but nothing really changed between yesterday and today. The UK is still in the EU at the moment, and many reports suggest the UK will remain in the EU for at least two years.

Of course risk still remains for financial markets, but let’s keep this in perspective. The U.S. does not really count on our exports (exports make up 13% of GDP). Remember that our consumer spending accounts for 70% of GDP. Said differently, it’s the economy and corporate profits that have the greatest impact on U.S. equities in the long term.

Keep that in perspective and filter this out for the short term. Life is about to get much more expensive for those living in Britain, but things just got a lot cheaper in Europe for the rest of us. I know some profits will be impacted by U.S. dollar strength, but the world is not going to end because of BREXIT.

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