In a long-anticipated referendum, British citizens voted in favor of their country exiting from the European Union (EU).
Britain’s Prime Minister David Cameron has resigned and Britain will now begin the multi-year process of negotiating its exit from the EU.
Think of it as a drawn-out, messy divorce.
Two main issues for voters were immigration control and free-trade pacts that some believe have sent jobs elsewhere. These are similar issues Americans grapple with as well.
Wider Impact
In my opinion, this decision will have significant implications for the future of the European Union, currency exchange rates and global financial markets.
Stock markets experienced a sell-off after the news. Yet, though there is a great deal of trading volatility, there hasn’t yet been the market chaos many feared.
What’s Next
In my opinion, here are the the likely immediate and longer-term impacts for global investment markets.
We immediately saw unprecedented pressure on the British pound sterling and the euro. The weakness in the pound and the euro hastened a flight to “safe haven” currencies such as the US dollar as well as the Japanese yen.
In my view the stronger US dollar will put pressure on American corporations that do business overseas. Additionally, a stronger dollar may add downward pressure on commodities and crude oil.
Sentiment Shift
Business sentiment, which has been lackluster but seemed to be improving, will most likely pull back once again, forcing corporations to slow down investment.
This may have a more pronounced effect on our domestic economy than trade with Britain, which amounts to only 4% of global GDP.
The US economy, though not currently running at full steam, is still a bright spot in the broader global economy.
Fed Policy
I believe the US Federal Reserve Bank will most likely further slow its pace of normalizing interest rates, providing support and more potential upside for US Treasuries and investment grade bonds.
Even with 10-year US Treasuries trading with a meager yield of 1.57%, that’s a level that is still high relative to other developed economies, many of which have negative yields.
The Federal Reserve and other global central banks, in my view, will continue to be “lower for longer” in regard to interest rate policy, especially as the global fiscal response remains muted.
Uncertainty Reigns
Market participants loathe uncertainty. Again, Brexit is an ugly divorce and it is heightening volatility into the markets given its broad ramifications on trade, regulation and labor.
It will ultimately manifest itself in ways not yet imaginable over the coming months and years as well. In my opinion, such an environment underscores the importance of a diversified portfolio.
Over the coming days and weeks, market participants will have to sort out how best to navigate the outcome of the Brexit referendum. The longer term prescription is diversity in asset allocation in my view.
Stay Calm
The short term prescription? Don’t panic and don’t try to be a hero, neither going completely to cash or all in the market. Financial markets need a chance to digest the changes underway, which will lead to clearer directions and new themes emerging.
For now, Brexit is unlikely to significantly change the fundamental outlook for US equities. Perception is another matter.
In my opinion, it is best to be patient as there will be opportunity to buy quality names on sale.
Photo Credit: Tomek Nacho via Flickr Creative Commons
