As usual, I found myself watching overnight markets and news coverage of the latest “Biggest Event Ever”. This time the “event” was the vote on “BREXIT” or, in other words, the United Kingdom’s decision to stay (“IN”) or leave (“BREXIT”) the European Union of which they have been a member since the early 1970’s. As the clock ticked past midnight here in the U.S. and 5 a.m. in London, the BREXIT camp was claiming victory and the “IN” crowd was in a state of shock.
As someone who once studied in the U.K., I love to see live images of U.K. landmarks. As I watched the Sky News coverage of the vote, I took note of live images of the Palace of Westminster and Clock Tower where Parliament and Big Ben are located. Images of red double decker buses and black taxis were also being shown.
Suddenly I took note of something. As I watched the sleep-deprived news reporters describe the impending crisis that will “undoubtedly” follow this vote, the sun started to shine on the walls of Westminster and the buses started to shimmer in the light. Sure enough, despite this vote and all of the doom it is predicted to bring, the sun still came up and the buses were still running and the taxis were still darting about. This was a visual metaphor to help offer perspective and context. The world is not going to end as a result of this vote. People are not going to stop living their lives because of this vote. What happened was a majority of citizens in a sovereign country decided to separate itself further from an economic and political experiment that they felt didn’t suit them. There have been worse events in human history than this one.
So how does this vote affect us? Our view is that this vote is a huge deal for the U.K., a big deal for the EU and just a deal for the U.S. Furthermore, don’t expect things to change quickly. The exit will take 2 years to complete. That is a very long time to allow markets to adjust. A new prime minister is going to lead the U.K. toward the formal exit. We expect this new leader will have the opportunity to add many shades of gray to this seemingly black-and-white decision. Cooler heads will prevail and the self-interest of the U.K. and EU will likely line up more than they seem to at this point.
In the short-term, we expect volatility to continue for several days but then it will settle down. While there is talk of other EU members leaving we don’t think this will happen. The U.K. has not been an “all-in” member anyway. They opted out of the single currency (Euro) and have not been obliged under several other EU authorities either. They were a country with one “foot” out of the EU and simply removed the other “foot.”
The Pound has dropped rather precipitously and this will be negative for the U.K. It will have a slightly negative impact on companies based in the U.S. that generate large profits in the U.K. There may be restrictions on U.K. citizens moving freely about the EU. It is hard to draw conclusive views on exactly how things will play out for the U.K. and the EU but it is even harder to see any outcome that is going to destroy the economy of either entity.
On the positive side, the trade deal that has been on ice which involves the U.S., China and the EU may start to thaw and move forward. This would be good for everyone involved. The U.S. will undoubtedly strike a trade deal with the U.K. that will benefit both parties and not be impacted by EU politics. It is worth noting that the U.K. runs a large trade deficit with EU countries. This means that they buy more from EU countries than they sell to them. It is unlikely that these EU countries will want to damage this relationship as it favors them. So, not all is negative following BREXIT.
In our managed accounts, we did trim back exposure to energy and increase our exposure to gold and other metals. These moves are providing some relief to the selloff we see today but it is still an unpleasant view. While there may be a spillover of negativity into next week, there is A LOT of cash sitting on the sidelines waiting for an opportunity to earn more than 0%. This weakness, we believe, will be seen as such an opportunity.
We believe our long-term view for equities remains positive. The short-term volatility is part and parcel to the transition from the flattish equity market of the last 17 years to that of an upward trending one. Many ingredients for this are in place now. Things such as low interest rates, low energy costs, strong balance sheets, lots of investable cash sitting idle, etc. will act as fuel to propel equities higher in the years to come. We will expand on this view in our upcoming letter to clients.
So, while the news has been presented as breathtaking, horrible and unprecedented and so on, we remain calm. The U.S. stock market, as we write this, has retraced about two weeks of recent gains. The Dow Jones Industrial Average is still positive for the year which is something we couldn’t say in February. More volatility will come on the heels of this event but we do not expect a contagion to take a hold from here. Is this the beginning of the end for stocks? We do not think so. In fact, we think the opposite.
For those who are able to tune into 1010 WCSI, you may find it interesting to tune in on Saturday’s from 9:30 a.m. for our 30-minute radio show. Tomorrow’s episode will touch on BREXIT.