Britain’s Surprising DecisionFriday, June 24th, 2016
This week many investors waited in anticipation for the outcome of yesterday’s vote in the United Kingdom. The question to be answered was “Should the United Kingdom leave the European Union?” The consensus view was that those voting “Remain” would outpoll those favoring “Leave.” Markets rallied as the vote approached; the S&P 500 closed within 1% of its all-time high on Thursday. But, as we have said in the past, “Forecasting is too hard, especially in the short-term.”
This morning, U.S. investors awoke to the surprising news that the UK’s citizens answered “yes” or in favor of “Brexit” by a 52% to 48% vote. An outcome that was once viewed as unlikely, if not impossible, became reality. The world’s investors reacted swiftly. In England, the benchmark FTSE has declined about 3%, and the pound traded at its lowest levels relative to the dollar since 1985. Germany’s benchmark DAX is roughly 7% lower. In the U.S., the S&P 500 is down around 3%.
Those market participants with a short-term focus are “heading for the hills” in the face of the market and political uncertainty. In our view, speculating on or reacting to what might happen is pure folly. We do not yet know the timing of Brexit or the details of how it will take place. Assuming Parliament votes to enforce this referendum (it could ignore the vote and “Remain”), Britain will have two years from that time to negotiate its withdrawal. In light of the uncertainty, there is little reason to act rashly to the “Leave” vote.
For the markets, we expect that the movements in the days ahead will be more extreme than we have seen over the past few months. In fact, it seems probable that on Friday, the S&P 500 will suffer its first decline of more than 1% in 55 days. It is likely to be the first of many more volatile trading sessions for the market.
There have been some that have speculated this could be a second “Lehman moment.” We disagree. The 2008 market collapse was the result of failures in the financial system and the end of a housing market bubble. What happened in 2008 was much more impactful to the global economy than Brexit.
At least in the medium term, the effect on the U.K. economy is likely to be negative. We expect market volatility in the U.K., as well as the EU as a whole, to increase. For what it is worth, mainstream economists forecast a 3%-7% negative long-term impact on U.K. gross domestic product.
While the rest of Europe will likely be hurt by Brexit, the near-term influences on the U.S. economy should be moderate at most. According to FactSet, companies listed on the S&P 500 derive 2.9% of their sales from Britain and 11.5% from all of Europe.
In the U.S., the likelihood of another Fed rate increase this year appears to have decreased. The yield on 10-year treasuries has fallen – it is currently 1.58%. Thirty-year treasuries are presently yielding a little more than 2.4%, which is only slightly higher than the S&P 500’s current yield of roughly 2.25%. This implies greater relative value in equities for investors. As long as the U.S. economy remains relatively stable, high-dividend paying stocks should continue to be a source of current income for investors.
Long-term investors should not let their emotions get the best of them. Overreacting to the latest news is not a beneficial approach. Markets can and will swing wildly in reaction to events such as Brexit. Retirement plans represent investments for the long haul, so it is unlikely that significant changes to portfolios are needed even in the turbulent market.
For long-term investors, times like these can represent an opportunity to add value. Some stocks are likely to fall more in reaction to the news than is truly justified. At BWFA, we are paying close attention to what is happening in the markets. We do not profess to have a crystal ball telling us what Brexit will bring. We do believe that the type of well-managed companies in which we seek to invest will be able to navigate these uncertain waters. We remain poised to take advantage of whatever opportunities the market may present.