Welcome to Brexit (by Bob Veres)

Thursday’s vote by the British electorate to end its 43-year membership in the European Union seems to have taken just about everybody by surprise, but the aftermath could not have been more predictable. The uncertainty of how, exactly, Europe and Britain will manage a complex divorce over the coming decade sent global markets reeling. London’s blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day, while Germany’s DAX market lost more than 7%. The British pound sterling is getting crushed (down 14% against the yen, 10% against the dollar).

Compared to the global markets, the reaction among traders on U.S. exchanges seems muted; down roughly 3% as you read this, though nobody knows if that’s the extent of the fall or just the beginning.

The important thing to understand is that the current market disruptions represent an emotional roller coaster, an immediate panic reaction to what is likely to be a very long-term, drawn out, ultimately graceful accommodation between the UK and Europe. German companies are certainly not 7% less valuable today than they were before the vote, and the pound sterling is certainly not suddenly a second-rate currency. When the dust settles, people will see that this panicky Brexit aftermath was a buying opportunity, rather than a time to sell. People who sell will realize they were suckered once again by panic masquerading as an assessment of real damage to the companies they’ve invested in.

What happens next for Britain and its former partners on the continent? Let’s start with what will NOT happen. Unlike other European nations, Britain will not have to start printing a new currency. When the UK entered the EU, it chose to retain the British pound’that that, of course, will continue. Stores and businesses will continue accepting euros.

On the trade and regulatory side, the actual split is still years away. One of the things you might not be hearing in the breathless coverage in the press is that the British electorate’s vote is actually not legally binding. It will not be until and unless the British government formally notifies the European Union of its intention to leave under Article 50 of the Treaty of Lisbon – known as the “exit clause.” If that happens, Article 50 sets forth a two-year period of negotiations between the exiting country and the remaining union. Since British Prime Minister David Cameron has officially resigned his post and called for a new election, that clock probably won’t start ticking until the British people decide on their next leader. For the foreseeable future, despite what you read, the UK is still part of the Eurozone.

After notification, attorneys in Whitehall and Brussels would begin negotiating, piece by piece, a new trade relationship, including tariffs, how open the UK borders will be for travel, and a variety of hot button immigration issues.Estimates vary, but nobody seems to think the process will take less than five years to complete, and current arrangements will stay in place until new ones are agreed upon.

An alternative that is being widely discussed is a temporary acceptance of an established model – similar to Norway’s. Norway is not an EU member, but it pays EU dues, and has full access to the single market as if it was a member. However, that would require the British to continue paying EU budget dues and accept free movement of workers – which were exactly the provisions that voters rejected in the referendum.

Meanwhile, since the Brexit vote is not legally binding, it’s possible that the new government might decide to delay invoking Article 50. Or Parliament could instruct the prime minister not to invoke Article 50 until the government has had a chance to study further the implications. There could even be a second referendum to undo the first.

The important thing for everybody to remember is that the quick-twitch traders and speculators on Wall Street are chasing sentiment, not underlying value, and the markets right now are being driven by emotion to what is perceived as an event, but is really a long process that will be managed by reasonable people who aren’t interested in damaging their nation’s economic fortunes. Nobody knows exactly how the long-term prospects of Britain, the EU or American companies doing business across the Atlantic will be impacted by Brexit, but it would be unwise to assume the worst so quickly after the vote.

But you can bet that, long-term, everybody will find a way to move past this interesting, unexpected event without suffering – or imposing – too much damage. Meanwhile, hang on, because the market roller coaster seems to have entered one of those wild rides that we all experience periodically.

Sources: https://www.yahoo.com/news/brexit-shows-global-desire-throw-142925862.html

https://www.washingtonpost.com/opinions/global-opinions/after-brexit-what-will-and-wont-happen/2016/06/24/c9f7a2f6-39f1-11e6-8f7c-d4c723a2becb_story.html

http://www.businessinsider.com/global-market-brexit-reaction-2016-6 www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html#ixzz4CVixCz25

http://www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html?ftcamp=traffic/partner/brexit/dianomi/row/auddev#axzz4CVide1Sz

http://www.newser.com/story/227149/brexit-now-what-happens-welcome-to-article-50.html

A Brexit Analysis (by Derek Prusa of FormulaFolios Investments)

The Brexit votes have been counted, the UK has decided to leave the European Union (EU), and David Cameron has stepped down as Prime Minister. According to reports the votes were geographically segregated as England and Wales were generally pro-leaving while Scotland and Ireland were generally pro-staying in the EU. The votes were also segregated across age and education demographics, with a clear trend of younger/more educated voters landing on the pro-staying side and older/less educated voters landing on the pro-leaving side.

It is clear the Brexit decision has had an immediate negative impact for the global equity markets, so why did a majority of voters (51.9%) want to leave the EU in the first place?

• Estimates showed that the gross cost of EU membership was about £350M/wk (but the net total economic cost is closer to £136M/wk after up-front rebates and the EU spending money on the UK). Pro-leave voters argued this money could be spent better elsewhere, such as new British industries and scientific research.
• The Common Agricultural Policy, a system of subsidies introduced in 1962 to support European farmers, is criticized as being too costly and wasteful. By leaving the EU, the UK can pursue more international trade deals with countries such as China and India rather than paying for the inefficient production of goods.
• One of the EU’s strongest principles is the free movement of people, goods, services, and money across borders. While part the EU, the UK would have no control over immigration from other EU member states. This was creating an issue on how to regulate welfare as immigration to the UK was becoming more prominent.
• Leaving the EU will allow the UK government more freedom to control healthcare, law, and international trade agreements.

These seem like sensible reasons for the UK to separate from the EU, but there are two sides to every story. There may be some foreseen, but unintended, consequences for the UK as well as the global economy in the coming months and years.

• The EU is the UK’s largest trading partner, accounting for about half of all UK imports and exports. Though the UK can enter into trade agreements with EU countries the terms will likely not be as friendly as they are at the current time, resulting in lower trading activity and increased trading costs between the UK and EU.

A Brexit Analysis (by Derek Prusa of FormulaFolios Investments)

• Scotland is expected to hold a referendum to leave the UK. In the most recent 2014 poll, Scotland decided to remain part of the UK arguing that the UK safeguarded their future in the EU. With the recent events, many expect another poll in which Scotland could separate from the UK in order to join back with the EU.
• The decision for the UK to leave the EU can be interpreted as a form of deglobalization and a step-down from free trade, which is a negative for both the UK and the global economy. Deglobalization will likely lead to lower GDP in the UK and could trickle over to surrounding countries as the current balance of imports and exports is interrupted. The UK is expected to go into a recession, but this could happen at a more global level as well.
• Foreign investment into the UK is likely to slowdown as investors will be scared away due to the large levels of risk and uncertainty surrounding the Brexit decision.
• There will be political uncertainty as the UK develops an exit plan from the EU. With the resignation of David Cameron and a new regime stepping in, there is not much clarity for the exit plan.
• The door is now open for other countries to attempt to leave the EU. Until now, no country had ever severed their ties with the EU. There is fear that other countries could follow suit in the coming years, resulting in a breakup of the EU all together.

Only one thing is certain at the moment: there are still many uncertainties surrounding the Brexit decision and nobody knows exactly how this will all play out. Emotions and panic can cause investors to make poor decisions in times like these, which is why it is imperative to stay committed to a smart investment strategy over the long-run. By avoiding the urge to make a knee-jerk reaction to daily news, long-term success is more likely to be achieved.

A Final Brexit Word (by Wayne Firebaugh)

The headlines have teased articles of cataclysmic economic doom and it would appear the world’s equity markets have been reading those articles. The Wall Street Journal’s online edition alone had seven “above-the-fold” articles including the ones with these terror-inspiring titles:

• Brexit Casts Pall on Global Economy; 
• A Revolution with No End in Sight; 
• Business in Europe is Cast into Uncertainty; 
• Traders Brace for More Volatility in Eurozone

Not to be outdone, the Old Grey Lady included a Sunday op-ed “This is Just the Start of Brexit’s Economic Disaster.” In its US edition, the British daily, The Guardian, published the “US Stock Market – A Toxic Blend of Uncertainty and Complacency” which helpfully cautioned against compounding the looming disaster of Brexit by electing Donald Trump.

No doubt, you’ve read these or similar articles. So I won’t reprise them here or regurgitate all of the things a Brexit might cause if it actually happens. The word “might” necessarily implies conjecture and uncertainty and the world’s securities markets hate both conditions. Fortunately, the Motley Fool provided a number of observations that represented neither conjecture nor uncertainty but rather historical facts – facts about the US stock markets where much of your retirement nest egg is likely invested.

How did the U.S. stock market perform over the last 140 years when adjusted for inflation?

And do you know what happened during this period?

• 1.3 million Americans died while fighting nine major wars.
• Three U.S. presidents were assassinated.
• 675,000 Americans died in a single year from a flu pandemic.
• 30 separate natural disasters killed at least 400 Americans each
• 33 recessions lasted a cumulative 48 years.
• The stock market fell more than 10% from a recent high at least 97 times.
• Stocks lost a third of their value at least 12 times.
• Annual inflation exceeded 7% in 20 separate years.
• The words “economic pessimism” appeared in newspapers at least 29,000 times, according to Google.

And the market still increased 10,000-fold.

A Final Brexit Word (by Wayne Firebaugh)

I have no doubt that the world’s stock markets will continue to serve as the visible expressions of concern and fear regarding the Brexit’s potential effect on the global economy. However, I ask you, in a moment reminiscent of Ronald Reagan just prior to the 1980 election, “are you better off now than you were four years ago?” Unlike Americans from 1980, today’s equity investors must surely answer “yes.” For evidence of this certitude, please consider the following chart showing the growth of the S&P 500 index for the past five years through June 24th.

Note that even after Friday’s market tantrum, the S&P 500 is still more than 600 points or 40% higher than it was just five years ago. And, although much has been made of its lackluster performance over the past twelve months, the S&P 500 closed Friday, June 24th only 4.47% off its twelve month high (2,132.82 on July 20, 2015) but a sweet 12.56% higher than its twelve month low (1,810.10 on February 11, 2016).

After confirming that you’re better off financially than you were five years ago, please consider whether your financial goals would again be better served by waiting for reason to replace fear and market gains to replace market losses. Then, avoid precipitous actions by allowing those clearly defined goals to drive your investment decisions even during periods when market clarity is lacking.

If, however, this latest market maelstrom gives you pause that perhaps your portfolio does not suit your temperament, consider checking your own risk “temperature.” The following button allows you access to a tool that will, within five minutes, provide clarity as to how you view the tradeoff between portfolio risk and volatility. Then, you can make a decision about your portfolio allocation independent of how the market is responding to a single series of events.