Dear Clients and Friends,
Great Britain’s overnight vote to leave the European Union has resulted in surprise and uncertainty on the part of investors, which are two of the market’s most disliked conditions. As a result, many markets are down this morning as investors adjust to the vote and what it means for economic and political stability in an important region of the world, as well as the impact on global companies who do business there.
Surprise came because the strong up day in the markets yesterday and the last polling data going into the vote itself seemed to indicate a vote for “remain” was gaining significant traction, with some polls indicating the likelihood of a remain vote at 70%-80%. Whether the polling led to complacency in terms of voter turnout for the remain camp or in fact the polling was flawed, in the end the “exit” vote’s 4% win (52%-48%) clearly has caught markets off guard. Uncertainty, another of the market’s most disliked environments, is also contributing to the sell-off because Great Britain’s vote for an exit from the European Union brings with it more questions than answers at this point. How will Great Britain’s exit work? Who will “hold the pen” in terms of drafting the procedures for exit? Will olive branches be extended and accepted to smooth the transition? Who might be the next member country to test the exit waters? Is British Prime Minister David Cameron’s resignation a sign of further political instability to come?
These questions will take time to answer, in part because the referendum itself permits up to two years for implementation. In the meantime, here are some observations. In the short term, emotions will dominate the markets, in the long term, economics will prevail. On that note, we would make a couple of points. One, Great Britain is different than other EU members in that they have their own currency, the British pound. This is a big difference from other EU members who do not have their own currency. Re-establishing a currency creates a far bigger hurdle to exit than what Great Britain has due to the existence of the pound, in our view. In addition, as First Trust economist Brian Wesbury pointed out in a note this morning, Great Britain runs persistent trade deficits with the rest of the European Union. The implication being that while there may be a lot of aggressive posturing on the part of the jilted EU, in the end those countries need Great Britain as a trading partner for their own economies and compromise will likely prevail. Furthermore, Great Britain may be able to cut their own trade deals with other countries that may have been hesitant to sign based on their entanglement with the EU itself.
In closing, whether Great Britain is inside the European Union or merely an associated trading partner like the rest of the world, the goods and services that companies produce and that consumers and companies around the world increasingly demand for their daily lives will still provide a backbone for global economic activity. Certain aspects of that activity may need to be re-plumbed under new regional trade agreements and that can be a distraction for a fragile global economy. However, in the end, in our opinion, it will happen and this vote and the associated market volatility will be another point of interest on the long march higher of the global economy, the capital markets, and the companies that compete in them. Please do not hesitate to contact us if you have any questions, comments or concerns that we may address.
John Micklitsch, CFA, CAIA
Chief Investment Officer
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