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The Impact of Brexit

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For my fellow central Ohioans, below is a “Clint’s notes” summary of a number of articles and analyses that may impact our clients and portfolios.  I’m sure many others have been following more closely and I encourage them to reach out to me with any thoughts or comments.

The European Union is an economic and political partnership that began after WWII to create economic integration and increase the desire for peace among the constituents.  It has grown to 28 countries, and for most of those countries (but not for Great Britain) they share a common currency as well.  Trade and the flow of residents amongst EU countries is extremely fluid and is modeled to be almost seamless.

While trade and travel is easy, many political issues have been decidedly difficult.  In short, very different cultures sharing common rules can be a recipe for stormy seas.  Amongst other issues, many British people had issues with EU immigration policies, budget and other issues.  In 2013, Prime Minister David Cameron promised a referendum on remaining in the EU.  Most believe that promise was to prevent Conservative voters from moving to the UK Independence Party (the “Independence” referring to being independent of the EU).

On June 23rd, that referendum was conducted.  While my perception was that the markets and all the talking heads were betting on the “Remain” vote, the polls were quite close leading up to the vote.  In the end, over 70% of the population turned out to vote to “Exit” the EU.

After those “Exit” votes registered, Cameron, the Prime Minister, who had essentially placed all his chips on “remaining” stated that

“the referendum was about this, and this alone, not the future of any single politician, including myself.  But the British people made a different decision to take a different path.  As such, I think the country requires fresh leadership to take it in this direction.”

As such, the successor to David Cameron will likely deal with the withdrawal.  Exiting the EU will be neither quick nor straightforward.  Article 50 of the Lisbon Treaty allows the U.K. two years to negotiate the terms of its exit.  This process has never been enacted, so there will be doubtless bumps in the negotiations.  Until the UK ceases being a member, the UK will still need to abide by EU laws and treaties- but just won’t participate in EU decision making.

There is a continuum of integration that the UK may have.  Norway, for example, is tightly integrated with the EU with few deviances (e.g. agriculture) however has no power in EU policies.  The UK could opt to have no integration with the EU which, at least in the medium term could potentially erect powerful barriers of trade and flow of people, which I imagine would be crippling economically.

From a portfolio perspective, we truly don’t know what the impacts will be.  We likely will not know what they are until a year or so has passed.  What we do know is that markets generally dislike uncertainty, so there will likely be higher volatility ahead.  This is a good time to be opportunistic, using volatility in the market to rebalance your portfolio. Other people’s fear may open up an asset class that you are over or underweighted in currently. For investors with a 1-2 year timeframe, perhaps lessening your equity exposure makes some sense.  Macro events should not drive investment decisions for long-term portfolios. For those with longer timeframes, the best course of action is to remain on the current course.

We don’t know if the market is going to go up or down but we do know one thing for sure, nobody else does either. Take a look at the horrible events over the past 100 years, yet the market still continued to move upward in the long term.

On another note, as the British Pound has dropped considerably, this may be a great time to visit Great Britain!

Author: Clint Edgington, CFA

Sources: 

https://next.ft.com/content/f1300fb4-3c5a-11e6-8716-a4a71e8140b0

http://www.bbc.com/news/uk-politics-32810887

http://www.lisbon-treaty.org/wcm/the-lisbon-treaty/treaty-on-European-union-and-comments/title-6-final-provisions/137-article-50.html

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