Market Bulletin: Brexit It Is

Friday, June 24, 2016
by M&P Research Team

In what turned out to be a big surprise for everyone – financial markets, politicians, pollsters, and gamblers alike – the UK narrowly voted on June 23rd to leave the European Union (EU). Through this past week, the British Pound and most global stock markets rallied strongly on the expectation of a Remain vote, largely reversing the nervous downward trend from the previous week. Unsurprisingly therefore, the vote to Leave upended the markets. The British Pound fell to levels not seen since the 1980s and European markets fell on a net currency adjusted basis around 8 to 10%. Asian, North American, and Brazilian markets fared slightly better – down around 3-5%.

In the days to come, many hours will be spent on dissecting why and how we ended up in the current situation. Barring some unexpected surprises, Brexit appears to be a fait accompli, so what is important now is what will happen in the future. Markets hate uncertainty, and there is certainly no shortage of it currently. What we know now is as follows:

  1. David Cameron, the current Prime Minister of the UK, has announced that he will retire in October. The Conservative Party will elect a new leader and PM at that point.
  2. The new leader will begin the process of formally removing the UK from the EU. As there is no precedent for such an event, the timelines are unknown. While the Lisbon Treaty requires an exit to be fully completed within a period of two years, depending on the complexities, this process could extend well beyond that time frame.
  3. Scottish leaders have suggested that they will hold another vote on Scottish independence. Scotland voted overwhelmingly in favour of Remain, so their desire to remain within the EU has been well established.
  4. UK will have to negotiate agreements with the EU and other countries on trade, access, immigration, etc. However, both the timelines and the true willingness of the counterparties are unknown. In the run up to the vote, EU politicians were fairly outspoken about their unwillingness to give preferential access to the UK, but this may merely be electioneering. Given that the UK has the fifth largest economy in the world (GDP of US$ 2.8 trillion), companies based in the EU would also suffer if they were not allowed reciprocal preferential access to the UK. Hence, there would likely be pressure from the business community to secure a deal.
  5. The G7, US Federal Reserve, Bank of Japan, Bank of England, European Central Bank (ECB), People’s Bank of China, International Monetary Fund, and other institutions have said that they are monitoring financial conditions and stand ready to provide monetary liquidity and other support, as necessary. In addition, the global financial system, and especially that of Europe is much better equipped to respond to financial turmoil than it was in 2011 when Greece first threatened to leave the Eurozone. Since then, the Eurozone and the ECB established several facilities that are designed to provide funding for governments in distress and buy corporate and government bonds. All these facilities substantially reduce the systemic risk that Brexit might exert on the global and European financial systems.

So you might say, well that’s great. But what does that mean for us?

Our team takes the view that neither Britons nor Europeans (and for that matter, citizens of the rest of the world), will stop living their lives due to this event. While there will be some short term uncertainty, particularly in the UK and Europe, people will continue to consume various goods and services that help them lead and improve their lives. The world will not come to an end and the sky will still continue to hang safely above us.  As expected, various forecasters and pundits are sparing no effort in predicting a multitude of doomsday scenarios. From a near term perspective they might indeed be correct; but in the long run, economics and human nature will prevail and these countries will revert to their natural long term rates of growth.

In the previous installment of the blog, we stated that we do not believe in making macro calls and that we do not bet on specific outcomes. Our research team and the entire firm remain committed to our investment philosophy and process. Stocks will be added to the portfolio only if they meet our criteria. Operating in this manner consistently over time will allow us to meet our clients’ performance objectives.



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