Pay Attention to What Might Happen, but Be Careful About Reacting to ItMonday, May 16th, 2016
In the United Kingdom, June 23 looms as being a potentially significant day. On that date, a referendum will be held to determine whether or not Britain will leave the European Union (collectively, Brexit). Should investors try to position their portfolios for a possible ‘Brexit?’
Investors regularly face such questions. The problem with acting before the answer is known is that we truly do not know what will happen. Nor do we know what the impact will be. Oftentimes, the best course is to simply wait and see.
For example, on a regular basis, we hear about proposed tax law changes. Will the corporate tax rate be lowered? Will rules allowing corporations to repatriate foreign earnings without incurring significant US taxes be implemented? Will the way individuals are taxed be simplified?
Proposed changes to these and other areas of the tax code have been bandied about for several years. So far, little has been changed. Many corporations have considerable cash in foreign jurisdictions. In many cases, they have chosen to borrow funds rather than pay the tax associated with distributing such cash to their U.S. parent companies. Underlying those actions is the belief (hope?) that the U.S. will enact some measure that will allow them to repatriate the money more cheaply. However, there is continued inaction on the part of the legislators to change these rules.
It is a virtual certainty that the major public accounting firms have invested considerable brainpower speculating on what changes might be made and what their impact might be. In the meantime, not much has changed; considerable time and effort have been spent with no discernible return on investment.
Similarly, we often hear of proposed changes to the federal budget. There are rumors that some programs will be cut and that more money will be allocated to others. Even when changes are enacted, we do not really know how they will turn out or what their ultimate impact will be. If we had a crystal ball that allowed us to know what might change and what the effect would be, we could certainly plan accordingly.
The discussion about a possible ‘Brexit’ is similar. Mark Carney, the Bank of England’s governor, has warned that the risks of leaving “could possibly include a technical recession.” The minutes from the Bank’s Monetary Policy Committee said that a vote to leave the EU could slow economic growth and cause the value of the British pound to fall. This would also cause unemployment to rise. A vote to remain as part of the EU would not settle the dispute that has become a semi-permanent element of U.K. politics. However, from a monetary policy perspective it could allow business to return to normal very quickly – U.K. data show that the debate is already weighing on the U.K.’s economy. However, if the decision is to stay, it is not certain how quickly economic activity will bounce back.
There has been considerable rhetoric about the possibility, but for investors, it is probably best to simply be aware of the situation. Trying to take action because of what might happen is often the wrong approach. In addition, it is likely that investors will realize greater rewards if they remain focused on identifying well-managed, financially strong, attractively valued companies with the potential to deliver long-term growth. If the U.K. does decide to exit the EU, an evaluation of the potential effects of such an action should be considered when investors have more information.