Thoughts on "Brexit"
In a surprising event, the United Kingdom voted to leave the EU. This is an unusual and unprecedented event, so commentary is admittedly a bit difficult. Economists, politicians, strategists and corporate decision makers are scrambling to get their arms around the situation. But, here are the facts:
- The final tally showed that 52% voted to "Leave" versus 48% voting to "Stay."
- This decision caught the world by surprise: In May, odds makers handicapped the likelihood of staying versus leaving at 80% to 20%. Though this spread narrowed to 60% / 40% in June, it’s clear the world did not expect this outcome.
- Following the vote, British Prime Minister David Cameron announced that he will step down from his post, exiting his role by October of this year.
- World markets responded negatively: The British Pound declined nearly 10% in the early going, reaching levels not seen since 1985.
This event clearly creates uncertainty and gives way to many questions including:
- What is the impact on the U.K. economy? Opinions differ but many are calling for a rough patch near-term.
- Will other countries follow suit?
- How do policymakers respond?
- Will this event tip the globe into recession?
Near-term implications for financial markets are many. Not surprisingly, we witnessed a flight from risk/flight to safety. Here are some considerations:
- Currencies such as the British Pound and Euro have weakened.
- The U.S. Dollar has strengthened.
- U.S. Treasuries have rallied and yields have declined.
- Fed’s efforts to raise interest rates may be pushed back.
In terms of equities, "riskier" stocks have been under pressure. Economically sensitive stocks, financials and international equities are disproportionately weak. The same applies to businesses with significant exposure to the U.K. and EU given potential currency pressures (e.g. Pounds or Euros translating back to fewer dollars) and the possibility of slowing growth. On the other hand, areas like utilities have shown resilience. Bottom line: this has provided another lift to the "quality trade" and furthered the "fear bubble" that has prompted investors to pay up for perceived safety and discount companies tied to improved global economic growth.
This is no doubt a seminal event in the history of the U.K. and the integration of Europe. For whatever reason, there seems to be an ongoing desire around the world to revolt against the establishment. The media, which we all know loves to create hysteria and turn events into crises/stories, has also played a strong hand in this event. Their greatest contribution may have been putting the letter "B" in front of words starting with "Re" (e.g. "Brexit" or "Bremain"). The question now is how much coverage this event will receive in the coming months.
What should we do?
It’s a little too early to make bold calls. But, we are watching for opportunities as this event unfolds. Many companies in our portfolios have very little exposure outside the U.S. and, absent a domino effect slowdown in the U.S., shouldn’t see their business impacted much by this event. The same applies to many U.S. small caps. Large companies with much more of an international bias will certainly be impacted, but share price weakness could create opportunity in some durable businesses.
Rest assured, we’ll be monitoring the situation as it unfolds in coming weeks. We have a feeling media hype will subside and we’ll be hearing much less about this a month from now. The U.K.’s exit will be a lengthy and complicated process that may result in less change than people expect. Some believe there may be a form of compromise and that the EU will make the process difficult to discourage others from leaving. All told, we are hoping cooler heads prevail and both economies and markets will get through this interesting time. As an aside, with the recent pullback, stocks are trading at levels similar to just two weeks ago. Remember, stocks tend to "climb a wall of worry."
The statements and opinions expressed in this article are those of the author as of the date of the article, are subject to rapid change as economic and market conditions dictate, and do not necessarily represent the views of Davenport & Company LLC. This article does not constitute investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. Investing in securities carries risk including the possible loss of principal. Individual circumstances vary.
Risk Considerations: Stock markets and investments in individual stocks are volatile and can decline significantly in response to market, foreign securities, small company, exchange traded fund, investment style and management risks. Small and mid-cap company stocks may be more volatile than stocks of larger, more established companies.