What we know – Early last Friday morning, final votes were tabulated in the United Kingdom (UK) confirming that voters had surprisingly chosen to leave the European Union (EU) by a narrow margin of 52% in favor of leaving versus 48% opposed. Shortly thereafter, British Prime Minister David Cameron announced his resignation. It should be noted that the referendum that passed is not legally binding. Parliament must still pass the referendum. Additionally, the process for the UK to leave the EU may take up to two years, which leaves the door open for negotiation between the two sides to find resolution without the UK leaving the EU.
What is the European Union? The EU is a collection of 28 independent countries in Europe that formed a political and economic agreement which allows free movement of goods, capital, services, and people between member states. Simply put, it is an agreement between the member countries that is designed to make each country better off as part of the group than they are individually. The UK was the second largest member country in the EU as measured by gross domestic product (GDP).
Why the UK voted to leave the EU? There were several reasons voters cast their ballot in favor of leaving the EU. The three largest catalysts for voting to leave the EU were:
How have markets reacted? The market has had a swift and strong reaction to the news. Over the past week, equity markets rallied on the belief that the UK would vote to stay in the EU. The market had priced in a vote by the UK to stay. With that vote not coming to fruition, investors are now repositioning themselves in light of the results of the vote that came as a surprise. The result is investors are buying perceived quality, or safe haven, investments like bonds and commodities (i.e – gold) and selling riskier assets like equities and emerging market investments.
What will we see in the market moving forward? In the short-term, investors can expect to see more market fluctuations given how many investors were caught off guard by the results of the vote. This volatility is likely to be exacerbated by the uncertainty that comes with this type of decision, namely that it could take up to two years to restructure all of the trade and political agreements for both the UK and the EU. How that process will go and what it will mean for the UK, the rest of the EU, and all of their respective trading partners across the world cannot be known right now. This type of uncertainty causes investors to sell risky assets now and ask questions later.
What does this mean for the EU and rest of global economy? For the EU, the immediate question is how will it function after losing its second largest member in terms of GDP. This vote has been coming for many months so one would expect the leaders of the EU to have discussed this exact possibility and what steps they would take if the vote was for the UK to leave the EU. Additionally, investors will be watching to see if this vote causes factions in other countries in the EU to consider holding a similar referendum to vote on staying in the EU, which would call into question the long-term viability of the EU and possibly the euro currency. For the rest of the global economy including the US, the impact of this decision centers on how business agreements will change between companies in the EU, the UK, and outside of Europe once the divorce takes place. This uncertainty of what the new world will look like will likely hamper business investment in the near term, which would hurt economic growth and as a result put continued pressure on global equity markets. At this point, it’s too early for anyone to definitively say what effect the UK’s decision to leave the EU will ultimately have on the UK, the EU, and the global economy. It’s this uncertainty that is causing investors to sell risky assets and buy higher quality assets.
Recommendations for Clients – For clients with concerns about what this news means to their portfolio, now is a good time to speak with your financial advisor to review your financial plan including investment objectives, risk tolerance, and time horizon. It’s important to remember that panic is not an investment strategy. For clients with a long-term time horizon, this news should not alter your financial plan. It is in fact these types of market surprises that serve as a reminder why it is important for investors to own portfolios that are well diversified among different asset classes.
Market uncertainty creates opportunity for investors. For clients looking for an opportunistic time to invest, this may be a good time to set up a dollar cost averaging program. If the market drops further, your next investment will be at an even better price. As investors, we cannot predict the future so we must plan for that uncertainty and focus on what we can control. That means making sure your financial plan is appropriately aligned with your personal investment objectives, risk tolerance, and time horizon.
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