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BREXIT - What Does It Mean?

Posted by RAA on Jul 6, 2016 5:30:00 PM


Market_Matters_Icon_medium.jpgBREXIT, or British Exit, happened on June 23, 2016, despite the almost universal feeling in the UK that BREMAIN, or British Remain, would prevail. The chart below from the Bank Credit Analyst shows that since January, on average, just 30% thought that BREXIT would succeed. Right before the vote, only 25% thought BREXIT would succeed. So much for the “smart” in “the smart money people.”

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The Brexit decision

As we take a look at how the voting went, central London (the money district), Scotland and Northern Ireland (yes, they are a part of the UK) all voted to stay in the European Union (EU). The rest voted to leave. So, what happens from here and why is it important? First of all, Parliament has to vote to leave, or stay, even though the people have voted to leave by 52% to 48%. If Parliament votes to overturn the will of the people, some members of the House of Commons might find that their political careers are over if they vote in contradiction to the will of their constituents. At this point we don’t see that happening, but you never know.

After that, the ruling party in the UK has to invoke Article 50 of the Lisbon Agreement. Once this happens, then the UK has two years to divorce itself from the EU. That timeline might be extended by an agreement by both parties because there are so many issues to settle, not the least of which are trade agreements, movements between EU countries without passports as is currently the case within the 28-memberEU (think going from Texas to Arkansas and needing a passport), immigration issues, UK citizens working for the EU in different countries, and the list goes on.

potential effects

So, why is this important? One of the positives is that this event has helped put the Fed on hold with respect to raising the federal funds rate. There is currently a 13% chance that they will raise rates in September (based on the federal funds futures contracts) and almost a 50% chance that they will raise rates in December. This could change. On the potentially negative side, the US doesn’t know what kind of trade agreements we will have with the UK. This may take a year or longer to figure out. Also, a bigger issue is what GDP growth will look like not only in the UK which, next to Germany, is the strongest country in the EU, but with other EU countries, as the EU now has to negotiate new trade agreements with the UK. There are so many interconnected issues that must be resolved that it almost boggles the mind.

Please remember that the EU was created in the early 50s, with six founding members, and now has 28 members, but will have 27 after the UK leaves. Since its founding, no member country has ever left the EU, so this is all a new experience for the EU and the other 27 members, as well as the UK. The next logical question is…will there be any other countries that choose to leave the EU? Remember that the EU, headquartered in Brussels, makes rules and regulations for essentially all members of the EU. It is not like individual countries have a say in these rules and regulations, unless they want to leave the EU.

At this point, we don’t think there are any other countries that are willing to exit the EU now, but many countries will be closely watching how the EU deals with the UK with respect to trade, free flow of individuals moving about, immigration, etc.

In conclusion, let us take a more global look at what could be happening. While we do not have the space or time for all of our thoughts, a few insights might be of interest:

  • In the late 80s/early 90s, globalization was the buzzword and that was the direction the world seemed to be headed.
  • This was followed by deregulation, privatization, low taxes, budgetary discipline and free trade. Is that direction now over with the rise of populism (witness the UK and what is going on in the USA) and the global talk of regulating borders?
  • Have we moved away from the laissez-faire attitude and globalization consensus?
  • Is the Goldilocks era for investors, in terms of economic policy, over?
  • In other words, instead of the “trickle down” theory, are we globally leaning to a more “income equality” world? 


All of this could have long-term ramifications with respect to inflation, GDP growth, corporate profits, etc. With respect to our portfolios, we remain overweight cash and underweight equity exposure. A week before the British election, we sold half of our Lazard International equity exposure as we were concerned about what COULD happen in the election with a populist uprising potentially taking place. It turned out to be a prescient move. 

 

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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds, and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Financial Planning