UK & EU: Brexit

As you’ve probably heard by now, Britain voted yesterday to leave the European Union. For a few reasons, this has roiled markets around the world, driving stock markets and other “risk assets” like oil and industrial commodities lower. Predicting the ultimate outcome of the situation for markets is virtually impossible, especially so early in the game, but we wanted to give you information on some of the things we think are relevant.

First, recognize that there’s initial shock on the part of investors to the news. Over the last week or two, most polls indicated that Britain would remain in the EU, and markets were generally rising on this line of thought. So today’s news was a surprise, and the fact that markets had been rising is magnifying the losses we’re seeing.

Second, there’s uncertainty about what will happen given the exit from the EU. The process of exiting could take up to two years (the relatively recently signed Treaty of Lisbon outlines how countries can leave the EU), but the market is reacting to the uncertainty that the vote has thrown into the equation. Things will not change overnight.

So while the shock and uncertainty is ruling market movements now, stepping back and looking at what the actual economic impact might be should provide some guidance about long-term implications.

Britain makes up only about 4% of the world’s GDP, so a hit to the British economy should not derail the continuing slow global recovery that we’re experiencing. It’s a big problem for a relatively small country. According to economists, the odds of a very brief UK recession have increased a bit because of the vote. We think it will become more expensive for British companies to trade with the EU in the future. The vote has made very little change to the currently low probability of a wider, European recession. Some commentators believe that long-term, a Britain that’s independent of the EU will be stronger economically. We believe that to be true, but it might be a 10 year process to get to that point.

In terms of US companies and the US economy, the vote should have relatively little impact. Based on other economic reports issued today, JP Morgan actually increased its forecast of US growth in the second quarter. They do not believe the UK vote will affect that.  Our economy should continue to grow as it has and companies’ profits and sales should continue as expected.

As I write this note on Friday morning, the Dow is down about 500 points on the day, so we will see losses in stocks today. It is interesting to note that over the course of this week, the Dow is only down about 100 points as of this moment, which is a virtual non-event. International stocks are down much more today, but even those markets have seen fairly orderly declines – we haven’t seen reports of panic selling. Most bonds are higher today since interest rates have declined, so they are acting as shock absorbers for our portfolio, which is why we own them.

Whether it’s a reaction to Brexit,  an election, fears of a recession, or a myriad of other things, the market sees days like this periodically. We will not get caught up in the emotional selling that happens, and will continue to focus on long-term implications and how that should guide us.

Please feel free to call us if you’d like to talk about our thoughts in more detail.