There are news stories galore on the effects of the United Kingdom leaving the European Union after Brits voted to leave the European Union, the so-called Brexit. However, there is almost nothing of substance in these articles and quick videos, just people wanting to go on the record and talk about the increase in market volatility (Thank you, Captain Obvious!), uncertainty, a fall in the British currency – the pound and a rise in U.S. Treasury prices and tell us “it’s too soon to tell.” Not exactly a lot of clarity. Let me see if I can do better.
Because most polls this week had a lead for the Remain vote, markets in Europe and the U.S. were up close to new highs with optimism. Part of the fall today, which ranged from 3% to 13% in Europe, with the weak, southern countries down the most and roughly 3% in the U.S., is simply giving back these gains. Part of the selling here in the States is from Europeans and global hedge funds selling what is easiest to sell.
Diversification – While oil and stocks are down, U.S. bond prices and gold went up nicely today. Real estate in the U.S. was unaffected, so diversification shows its value once again.
US. Interest rates – Janet Yellen will probably have a very hard time raising rates more this year because the Brexit vote has people thinking about recession in Europe.
Travel costs to England, Wales, Scotland and Wales just went on sale by 10% because of the fall in the pound sterling, the British currency. Remember that the UK never adopted the Euro currency.
European economic growth – This may dampen UK and to a lesser extent, the Eurozone’s economic growth, which has been anemic, but this effect should take years to play out. The biggest reason for it is that it will be harder for Eurozone laborers to get jobs in the UK because it will mean getting a visa and at the same time makes it harder for British businesses to hire from the continent. Plus the flow of goods will be more difficult.
But, the negotiations over issues like this will take at least two years according to the Lisbon Treaty. I am hearing that some details may take 10 years to get worked out. For the UK, the currency drop means their exported good just got 10% cheaper and imports 10% more expensive. In one day. That’s a boost both to export growth and to local inflation.
US economic growth – Europe is our largest trading partner, so any weakness there affects our export business to some degree. The 2% rise in the US dollar against the Euro makes our goods a little more expensive overseas. That is especially so against Japan, whose currency also dropped roughly 10% today for this and other reasons. On the other hand, cheaper oil saves consumers and businesses money.
US corporate profits – A slightly stronger dollar means that currency translation will work against profits for multinational companies based in the US. US profits are already weakening some the last couple years.
Immigration – Without Britons worrying about their jobs in the face of the unstoppable flood of immigrants from Europe and worrying whether the many Muslim immigrants have terrorists among them, there would have been no Brexit, not even a vote over it. This is really the heart of the matter, though some will cite Brussels having too much control over Britain. What they really mean is that Brussels mandates the free flow of people from one European Union country to another and Brits have had no say in that, though there are other less contentious issues as well.
US election – Donald Trump really rides the same wave of voter discontent and fear of immigration and terrorism that the British Leave party did. Predictably, the Donald applauded the Leave vote as a validation of his antiestablishment campaign. It is largely the same demographic – working class whites who worry about a link between terrorism and immigration, who have lost all respect for leadership from a capital far removed in many ways from them, who worry about their jobs and who have seen no progress in their wages for quite some time while they see the rich get richer. Don’t underestimate the class warfare element of either campaign.
Fear – Sudden, unexpected news make people nervous, as do sudden drops in stock prices. Realize that the media loves to feed that fear, as do politicians (think of the rush to immediately pass widespread gun control legislation after an Islamic terrorist killed dozens of people in a nightclub). You may disagree about the 2nd Amendment but no one can argue that the media and politicians don’t jump on crises. “Never waste a crisis,” Saul Alinsky wrote. Calm down and take the time to think things through. As I said above, the economic consequences people are worried about will take years to work out, not days, and many other factors will come into play.
Media hyperbole – Don’t let the media’s breathless hyperbole rattle you and make you rush into panicked decisions. This is nothing like the 2008 financial crisis in which people legitimately worried about whether companies like Merrill Lynch and Prudential and large banks were going out of business. Sometimes the media gets so focused on one thing that it seems like which way it goes will immediately plunge the world into chaos. That is far overstating the case here.
The continuation of the European Union – Britain held a unique position in being an EU member but not fully so because they never adopted the Euro as their currency. Britain is not part of the continent, as the French will tell you, and always felt a bit apart. There is no reason to believe that this the start of a waterfall in which countries begin to peel off the EU. Greece should go for its own good, but is generally opposed to that.
Stocks – You will likely see some more selling in European stocks. You could see some more short term selling in U.S. stocks. Part of that is giving back the recent gains and part of it is that selling begets selling. The market is also at the top of its recent trading range. Stick to your long term allocations. Market timing based on world events usually ends up being a losing proposition.
I hope that helps put things in perspective a little better. Please let me know if you have questions or concerns.
Dave Hoshour AIF, MBA, MA
Cornerstone Investment Services
A Fee-Only Investment Advisor
10800 Sikes Place Suite 300
Charlotte, NC 28277