Britain’s Relationship With The EU & The Effects Of Brexit – EU Overview

Following the decision to exit the EU, the next step is to start the actual process. When the EU was established after WWII, a clause was inserted into the EU agreement to address any countries that should want to terminate and exit in the future. The clause is known as Article 50 and establishes the balance of power for ‘divorce’ talks. It also establishes the voting rules for determining how to part ways and sets a two-year deadline on talks that can only be extended by a unanimous decision of the other 27 EU countries.

While starting the formal break-up process is in the hands of Britain’s Prime Minister, a decision on how and when to end it would not be. Britain’s departing Prime Minister, David Cameron, did not trigger Article 50 and is leaving it to his successor, to the annoyance of those in the EU who want a fast and efficient break. Only the British government can decide when to invoke Article 50 as it is not designed to oust a country from the EU.

Immigration has been at the root of contention, as Britain’s net migration stood at 333,000 in 2015, the second highest figure on record for the country. Net immigration from EU countries, particularly central and eastern European member countries, rose rapidly after their accession to the EU in 2004 and offered migrants the ability to work and settle in the UK. Only by leaving the EU can the government reduce the number of EU migrants.

With a population of over 500 million throughout the 28 EU countries, the United Kingdom represents 12.7% of the EU’s total population, one of the larger components making up the EU. The union was developed as an integral single market through a standardized system of laws that apply to all 28 member countries, thus allowing for the free movement of people, goods, services and capital.

On a global scale, the EU covers over 7% of the world population, made up of distinctive cultures and languages, all sharing the same financial and trade laws. The British approval to exit the EU is the catalyst for the end of European cohesion and symbolic of a rejection of status quo throughout Europe. International companies and multinationals may now express less interest to expand or hire in the UK as the uncertainty of the EU detachment unfolds.

Sources: Eurostat, europa.eu

Equity Update – Domestic & Global Stock Markets

U.S. stocks fared better than international stocks following Britain’s announcement on leaving the EU. U.S. equity markets were resilient once the surprise of Brexit unfolded, with the S&P 500 Index and the Dow Jones Industrial Index both remaining positive for the year. Most U.S. large cap domestic equities are well insulated from global developments since 70% of their revenue is generated from within the United States. For comparison, Japanese companies generate 50% from within their economy, and European companies generate 49% from within Europe only.

With the U.S. 10-year Treasury rate below 1.5% and many international government bonds offering negative interest rates, there is a strong upward bias toward U.S. Equities. Over 60% of the companies in the S&P 500 index currently offer dividend yields higher than the 1.5% 10-year treasury.

The British equity index, the FTSE 100, tumbled in June following the Brexit vote. Companies within this index generate approximately 75% of their revenues outside of the U.K., with many maintaining contracts and arrangements with other businesses based in other EU countries. There is a high probability that decisions for capital spending and expansion by companies will be hindered by the uncertainty surrounding Britain’s divorce from the EU for the foreseeable future.

Bonds Worldwide React To Brexit – Global Fixed Income Update

As government bond yields turned negative throughout Europe, rates overseas in the U.S. and in Asia also dropped to new lows. The U.S. Treasury 10-year bond yield stood at 1.49% at the end of the June, a level not seen in a very long time.

The U.K. was stripped of its AAA credit rating by Standard & Poor’s, lowering the rating to AA. Such a change theoretically makes it more difficult for the British government to issue inexpensive debt. S&P cited the downgrade due to an increased risk because of a less predictable, stable, and effective policy framework in the U.K. S&P also noted that the U.K. has the highest financing needs among all of the 131 countries it follows and rates. The U.K. now has a worse rating from S&P than the U.S., whose rating was famously lowered by the credit-reporting firm in 2011, even after the downgrade was adamantly contested by the U.S. Treasury and government.

With the decline in yields around the developed markets, the flight to quality and safety of the U.S. Treasury market seems to be attracting global buyers even at lower yield levels. U.S. fixed income markets solidly outperformed U.S. equity markets as of the end of the second quarter, with corporate, municipal, and government fixed income sectors all advancing. An oddity to the current environment- bonds kept pace with rising commodity prices, whereas historically, bonds tend to lose value as commodity values increase.

Sources: Moody’s, S&P, US Treasury, Federal Reserve

Less Men Are Working – Labor Demographics

The Council of Economic Advisors, an agency within the Executive Office of the President, released a report in June identifying the fact that less working age men are working. The report found that the participation rate for men between the ages of 25 and 54 fell more steeply than in all but one country in the Organization for Economic Cooperation and Development (OECD) from 1990-2014. The U.S. rate is now the third lowest among 34 OECD nations. The participation rate is a measure of how many employable men are willing and able to work, thus participating in the labor force.

The male labor force participation rate peaked at 98% in 1954, and has fallen to 62.6% in May of this year. It is of particular concern since workers are at their peak productivity and earnings from ages 25 to 54.

Part of the reason behind the fall in demand for lower-skilled labor is the drop in manufacturing jobs, resulting in technological change.

The World Bank also tracks the participation rate for men and women worldwide. Its data reveals that women throughout the world are working more. Opposite of the gloomy male statistics, the participation rate for females has steadily increased worldwide. We attribute a significant portion of the recent increase to advancements in technology, enabling many new jobs to be gender neutral.

Sources: The World Bank, OECD, Council of Economic Advisors