What seemed unthinkable to many as recently as two weeks ago has now happened: The UK citizens voted to leave the European Union after 43 years of membership. However, nothing will actually change for a while because the UK will still be a member of the EU for at least two more years. It is also very possible that they stay in the EU longer as part of the negotiations that will begin immediately. This surprise result on the Brexit vote adds to uncertainty around the world.
Why it happened
While there are several reasons behind the underlying exit vote, the biggest reason cited by voters was to gain control of immigration, which has spiked since the UK joined the EU. This is due to the “opening” of borders amongst other EU countries and has caused a large influx of immigrants from around the EU. This vote became about controlling who is entering the country, and the voters clearly sent a message that they do not believe open borders are in the best interests of the UK. The anger and discontent of the British citizens is the reason behind the Brexit vote. Britain is a sovereign nation and its people are supposed to be able to determine who makes political decisions, through a democratic system. But now many decisions the British people consider important are made by unelected European bureaucrats. Parliament was not supposed to be able to “delegate” decision-making authority to foreign capitals. To some in the UK it seemed like the EU had become a dictator. International trade is generally freer because of the EU and that’s a good thing. But the voters decided it is not worth it to trade sovereignty for freer trade. Immigration and the huge cost of the welfare benefits immigrants can get should be decisions that the people they elected make. That’s what Margaret Thatcher would have wanted and the UK voters made it clear that they want to be in control of these types of decisions in the future.
David Cameron, the Prime Minister of the UK, stepped down after the vote results came in. This was largely a “falling on his sword” move, because even though he was against an exit, he was the one who put it up to the vote for the people to decide the result, largely because of his confidence of a Remain vote. Boris Johnson, former mayor of London and one of the leading voices for an exit vote, is now considered to be the leading candidate to succeed Cameron as PM. If he is elected he has an incredibly difficult task of keeping the UK economy from falling into disrepair. The leaders of the campaign to LEAVE the EU did a good job keeping the message focused on WHY they wanted to leave the EU but they did not formulate any plan on HOW they would keep the UK economy from falling apart in the aftermath of actually winning the vote. Like many political campaigns they were able to use emotions to get the result they wanted, now they will be under a microscope to deliver a better result for voters in the future. Our view is that they have stepped down a very slippery slope but it may be a wakeup call to the leaders of the EU to start listening to the people that are fed up with all the political pandering.
Risk to the European Economy
The biggest fear is the uncertainty surrounding whether this is the begging of the end of the EU. Skepticism has been on the rise as to the benefits of the EU, and this event may trigger other members to consider withdrawing as well. We are currently unsure of how the EU will treat the UK, from a trade perspective. Currently, the UK has trade agreements (through the EU) with the other 27 countries. These will all need to be re-negotiated, and while the UK has two years to do so before the official exit, EU countries may offer less than favorable terms and will look to punish the UK as a “warning” to other countries potentially considering leaving the EU. They will have to balance their desire to punish the UK with the impact to the EU economy. The EU will suffer if they do not work with the UK because they are one of Europe’s biggest export markets. They may have to come back to their senses and negotiate with the UK. In addition, the Brexit vote may actually open a door for the US to sign a free trade deal with the UK – something that the EU has been holding up.
What does this mean for markets?
The market pullback we are experiencing today is not unexpected, as the last few days we have seen markets on the rise due to the anticipation that the UK would remain in the EU. As a result of the outcome, we were due to give those gains back. Interestingly, markets in Germany and France are down more than the UK. Not surprisingly, Spain and Italy, countries that have historically needed more support from stronger EU countries are plummeting and are down nearly 10% as of this writing.
Though the Pound Sterling is falling in relation to the US Dollar, which should make UK exports cheaper and more desirable, the UK does not have a large manufacturing/export base. The weaker currency will also have a negative impact on foreign investment and UK will almost certainly lose some jobs, especially in the financial sector in London, which has a large amount of foreign companies. Perhaps what is most unsettling to the markets is whether other countries will also exit the EU which could, in an extreme circumstance, dissolve the EU. However, this seems unlikely from where we are currently sitting. The short term sell off should not lead to any major correction because the global economy is NOT going to fall off a cliff over the UK leaving the EU. Most U.S. businesses will not have any material impact to their earnings as a result of this event. Investors in Europe may actually decide that the U.S. stock market is a safer place to invest money in the midst of the uncertainty this has created.
Where do we go from here?
While the uncertainties will cause some short-term volatility, the best course of action is to stick to your long-term investment strategy. There are always one-off events like this that we will see the media try to spin into “doom and gloom”. It wouldn’t be very good TV if someone came on and simply stated that pullbacks are a normal part of a market cycle and that, long-term, keeping a diversified portfolio will more often than not beat staying in cash or trying to time the market on events like this. Late last night, futures markets (which retail investors rarely trade in) were selling off and indicating the Dow falling over 600 points. Many of these traders are simply looking to push the market one way or another in the short-term (in this case downward) without any thought of the long-term implications. As we stated above, we still have two years of the UK remaining in the EU and we largely expect that this is sufficient time to get all the terms and conditions negotiated between the UK and the remainder of the EU.
While days like these are sometimes tough to stomach, the US markets are not any worse off than they were last week. The Dow Jones Industrial Average is up 539.78 points from its low last Thursday so we are giving some of these gains back. The ECB already has come out and stated they have the tools necessary to continue to stimulate the Euro economy, should that action become necessary. Therefore, while this is a historic event, it largely should not affect an investor’s long-term strategy.
The bottom line is that, while there are still uncertainties, markets adapt. Businesses do too. We do not expect U.S. companies to be impacted in any major way just because of a vote in the UK. Many of them won’t be affected. Those that do business abroad will continue to find ways to continue to make money, as they always have. The same goes for foreign companies, including companies in the UK. Of course, we are always watching developments like these very closely and we will update you should our thoughts change.
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