Don't expect return to normality any time soon. This is bad. Taken from a US viewpoint, but applies everywhere.
We all know by now that Britain voted to leave the E.U.: the so-called Brexit is
underway.
Unfortunately, it isn’t that simple as far as investors are concerned. What
matters now is what happens next. What are the broader implications of the
decision and what moves can be taken to at least minimize the damage, or maybe
even profit from the market disruption?
Let’s look at each of those questions separately, starting with the political
and economic implications.
Consequences Of The Vote
1. The U.K. Prime minister, David Cameron will step down. Cameron has already
announced this, but interestingly will resign effective in three months time,
which leads to the second point...
2. Nothing will happen quickly. This is an unprecedented event; there is no
blueprint as to how that actual exit will proceed, and negotiations will
probably drag on for years
3. In a broader sense, it will endanger the European Union. The victory for the
“Leave” campaign in Britain will embolden and strengthen anti-EU voices in other
countries. Those voices are already being heard, most significantly in France,
Italy, and Greece. Whether they succeed or not will largely depend on the extent
of the visible economic damage to the U.K. over the next year or so. A complete
collapse of the E.U., and therefore the Euro, is unlikely, but possible, and
would be devastating to the global economy if this takes place.
4. It will endanger the U.K.’s existence. In many ways, this threat is more real
and immediate than the one to Europe. Sinn Fein, the old political wing of the
IRA, has already called for a vote on a united Ireland based on the fact that
Northern Ireland voted to remain. Given that Scotland voted overwhelmingly in
the same way, renewed calls for a referendum on their independence will surely
come. If the nationalists in both cases get their way and then make it a single
issue vote, they would probably win.
5. Both the U.K. and the Eurozone will suffer economically over the next couple
of years. Every economic entity that has studied the effects of a Brexit has
concluded that this will be the case. Even the pro-leave campaign has admitted
as much and the massive drop in the Pound tells you that the market believes it
to be true. Recession looks almost certain in the U.K. and distinctly possible
in Europe.
6. That weakness will spread to the U.S. economy. This is less certain, but
looks likely to some degree. Trade accounts for 30% of U.S. GDP and Europe,
including the U.K., makes up 11% of that. The direct impact should not,
therefore, be too large, but the knock on effects of slow or negative growth
throughout Europe will still have an effect. At the very least, fears of that
have made it much less likely that the Fed will raise rates this year.
From a strategy perspective, then, there are several conclusions that can be
drawn.
What Investors Can Do Now
1. At some point, U.S. stocks will represent value. Of course, what matters here
is the timing. Usually, when the market is positioned wrongly going into news,
the immediate reaction is an overreaction, but this is different. This may be an
event, but it has long-term economic consequences, and as they sink in further,
selling early next week would be no surprise. Wait and see is the best policy,
but by the end of next week some value should present itself.
2. Yield is the place to hide. Given the likely impact on the Fed decision,
dividend payers such as utilities and telecom stocks, and things like REITs and
maybe even MLPs will outperform the broader market
3. Stick to the U.S. market. The huge drops in the British, European and
Japanese stock markets may look tempting, but they are the result of very real
potential problems.
4. If you are investing for more than a few years in the future, do nothing.
Times like this just have to be ridden out by long-term investors. If you have
extra cash to invest, wait a while and then begin dollar cost averaging in once
the dust has settled. If you feel you must do something, then a small investment
in something like VXX, which tracks the VIX or SDS, a leveraged S&P 500 Bear ETF
will provide some insurance and give you some profit to offset losses if the
drop continues.
The thing to remember above all else is that the only thing that is certain at
this point is that there will be uncertainty. The decision by the U.K. voters
will have a lasting impact, both politically and economically, but how severe
the effect will be on U.S. investors cannot be known. There will be volatility
as things play out and it will take a lot of patience to ride that out, but
ultimately that will, as is most often the case, probably turn out to be the
best policy.
