The Battle of Britain’s Exit

By Aradhana Kejriwal   |   June 23, 2016

Brexit Vote - GV FInancial Provides Analysis

The Brexit vote is today. Most economists agree that leaving the EU would impair the UK’s economy, but voters concerned with British identity remain determined, stirring markets on both sides of the pond. Should US investors worry?

Investors in Britain appear to have made their preference known. On Monday, as new polls suggested voters are less likely to support Brexit, the FTSE 100 rallied and the British pound posted its biggest daily rise in the last eight years. (See this BBC story for all you need to know about the June 23 referendum.)

So, if most agree the economic consequences of the Brexit would be significant, why do so many British voters support the UK’s withdrawal? As a Behavioral Wealth Management firm, we recognize the irrational behavior being exhibited by the Brexit supporters. As Jennifer Lerner, Professor at Harvard’s Kennedy School of Government, explained:

Traditional economic theory has assumed that people make decisions in a so-called rational way, and therefore, they will calculate costs and benefits, and focus only on decision-relevant criteria. That’s not how people make decisions at all.

Will Britain vote to leave the European Union? We don’t know.

Should Britain vote to leave the EU, we believe volatility could be tumultuous over the short-term, but the long-term impact to investors likely would be limited. Below, we briefly review what Brexit might mean for the global economy, the markets, and investors.

1. The impact on the global economy is likely to be minimal, but Britain and the European economies would feel the brunt of Britain’s exit from the EU.

While Rule, Britannia! still might be part of our collective consciousness, jolly old England is no longer the dominating economic force it once was. Today, the UK economy accounts for just 2.4% of the world GDP. So, while the global impact is not expected to be significant, the potential impact for Britain and its European trading partners could be significant in the short term given:

  • the currency impact;
  • the possible trading costs;
  • the cost of re-negotiating agreements;
  • deregulations;
  • potential trade flows; and
  • a possible recession in that part of the world.
UK depends more on EU exports than the other way around.

UK depends more on EU exports than the other way around.

As the IMF chart above makes clear, the UK needs the EU more than the EU needs the UK. Moreover, with the U.S. accounting for just 15% of British exports compared to 44% for the EU, Brexit’s impact likely would be far more pronounced “over there” than here in US.

Regardless of the referendum’s outcome, there is one bright spot. The removal of uncertainty—which has already cost British companies and European investors—should be a relief for investors and the global markets. It could take years to determine if Brexit is an economic success or failure.

2. Markets might experience heightened volatility in the short term.

Assuming a vote in favor of Brexit (and recent polls suggest the likelihood of a Brexit has fallen), a decision of this magnitude could further increase market volatility in the near term (volatility, as measure by the VIX, has already accelerated in the last three months), but given the complexity of unwinding the UK/EU connection, the long-term impact on the global and US markets is harder to gauge. The UK stock markets have fallen 8% over the last year while the US markets are down far less, approximately -1%.

Going forward,

  • We would expect European equities to be more prone to the short-term impact of a decision to exit the EU than US equities.
  • We already see evidence of heightened volatility in the currency markets, the treasury markets and in gold, and we would expect that to continue over the short term.
  • We would expect the long-term impact to global stocks to be low given the small exposure of British companies to the global economy.
  • The wild card is global investor sentiment: the symbolic effect of a Brexit may have a greater economic and market impact across the world than numbers alone might suggest.
3. Brexit likely to have limited impact on GV’s globally diversified portfolios. 

GV portfolios are diversified across the global markets, meaning that GV portfolios do have exposure to developed international markets. For example, EFA, an international ETF that provides exposure to a broad range of companies in Europe, Australia, Asia, and the Far East, has 14% exposure to Britain, but that exposure is offset by allocations to other asset classes and other nations.

In advance of today’s vote, we have spoken with the international managers we hire and are confident that they are not only keenly aware of the upcoming vote, they are actively managing their portfolios, alert for opportunities that might arise from the referendum’s result. Moreover, several expressed optimism that a pro-Brexit vote would allow them to purchase desirable stocks at a discount and are evaluating entry prices for British companies that might be trading at a discount from the uncertainty created leading up to today.

Avoid Brexit’s media frenzy – focus on your goals.

If you’re struggling to maintain the quintessentially British stiff upper lip, we want to remind you to keep the possibility of Brexit in its proper perspective. Instead, focus on something other than the news so you can avoid being swept up in the media frenzy.

Even if Britain does vote to leave the EU, little will change overnight. The parties have two years to negotiate the terms of Britain’s withdrawal, and a lot can happen in two years. There’s the fearful story the media offers and a host of mundane alternate stories that are just as likely.

Investors typically want to make investment decisions based on possibilities, but since literally almost anything is possible, we believe smarter decisions are made based on probabilities. In the last five years, we’ve seen a number of hysterical fears come and go: the fall of Euro, the 2014 Russian Financial Crisis, the Greek government debt crisis (Grexit), the Ebola crisis, the US debt ceiling crisis, the collapse of oil prices, and the capitulation in Commodities, just to name a few. Yet despite all these possible calamities, over the same period, the global markets (MSCI ACWI) have rallied and are up almost 22%, demonstrating the value of making investment decisions based on rational probabilities rather than emotional possibilities. While a significant market decline – should the Brexit referendum pass – is possible, it’s probable that any market decline likely would be temporary.

Conclusion

Although Britain votes on Brexit today, we doubt it will be the last we hear on this topic. The level of confidence in the vote could hint at what the future might hold for the UK and the EU. It also could serve as a signal to the many countries looking to flatten the globalized world. First Grexit, and now Brexit, have challenged the era of free trade and open borders; protectionism could gain strength.

We expect some short-term impact on the global markets, but less direct impact in the US. GV’s globally diversified portfolios should be well-positioned to withstand any short-term Brexit fallout. If you are a GV client, you already have a thoughtfully-constructed globally diversified portfolio that takes into account both your short-term income needs and your long-term growth needs.

We remain confident that your GV portfolio can weather whatever short-term consequences Brexit might bring. Together, our challenge is to help you avoid making emotional decisions about your investments. At GV, we stay focused on investment fundamentals – keeping costs low and tax efficiency high, while rebalancing and seizing opportunities as circumstances dictate – rather than caving into fear or frustration brought on by the daily market noise here or from across the pond.

Aradhana Kejriwal

About the Author

Aradhana Kejriwal, CFA®, is JOYN's Chief Investment Officer and co-chairs the Investment Committee, which formulates and implements the firm's investment philosophy, strategies, processes and procedures. With 19 years of investment experience, she's a popular industry writer and speaker.

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