Stock markets around the world rallied this
week while the British pound strengthened. This
action has swiftly reversed with the global equity
markets off, bond yields plummeting, and the
pound dramatically weaker. Not surprisingly, gold
has rallied. The vote has clearly caught markets on
the wrong foot.
This immediate reaction has been swift but is likely
to reverberate across time zones in the coming
days. Perhaps the three most immediate questions
will be: What will a new government in the UK look
like? Will the EU offer to renegotiate more
favorable membership terms in light of the “Leave”
victory? How soon will the UK invoke Article 50 to
begin the withdrawal process? These questions will
bring a high degree of uncertainty and may
continue to pressure asset values globally, but
more directly across Europe and the UK.
The longer-term implications of the “Leave” vote
are more difficult to handicap. For the immediate
future, the UK will continue to exist under EU law
throughout the withdrawal process. However,
businesses will quickly begin assessing the new
landscape of how they will operate outside of EU
oversight post-withdrawal. This uncertainty will be
just another headwind constraining activity across
Europe in a period where organic growth has
already been difficult to find. The developed
economies of the U.S., Japan, and Europe have
been unable to come up with a catalyst to shock growth meaningfully higher. The “Leave” vote will
make finding this catalyst even more difficult.
Perhaps more damaging will be the longer-term
effects on the European Union. Given that euroskepticism
has been on the rise, the precedent set
by the Brexit vote may compel other EU members
to contemplate withdrawal. Unless EU leaders can
better unify their members in both philosophy and
policy, the union could face a more existential
threat in the years to come. In this regard, the EU is
likely to be an onerous counterparty in the UK
withdrawal negotiations, if only as a deterrent to
other nations. This again will bring more
unknowns, more uncertainty, and more volatility
across assets.
In the coming days, investors will be buffeted by
conflicting data, new risks, and wild price swings.
The macroeconomy, already laboring under subpar
growth, may stumble again. But asset price
volatility is often an overreaction to the underlying
economic fundamentals which evolve more slowly.
Activity across the UK and Europe will not come to
a standstill. Companies will continue to produce
and employ – despite the clouded outlook. Central
banks will likely supply additional liquidity to act as
a firewall against further contagion. And policy
makers will quickly seek to address areas of acute
vulnerability. The next few days will certainly test
investors’ tolerance for risk.
It is also a time to review portfolios and reassess
the opportunities a Brexit vote may uncover. For
starters, extreme price moves bring with them the
chance to rebalance and reset portfolio allocations.
Stock valuations, which have been elevated
recently, will look more reasonable. Plunging bond
yields will result in previously unthinkable (and perhaps temporary) gains in fixed income
allocations. While rebalancing can’t prevent losses,
it helps to mitigate a potentially larger problem –
the risk that the portfolio wanders too far from its
long-term risk/return objectives. The market
calamity following Brexit may also provide a good
opportunity for investors to assess their true risk
tolerance. “Can I live with this level of volatility?
Do I have the stomach for this?” This type of
financial self-assessment can only be done during
periods of actual losses. It cannot be simulated in a
lab or understood from the textbooks. For those
investors unfazed by these market gyrations, what
ideas have emerged? Which assets now look cheap
and can be purchased “on sale”? Which assets
have become more overpriced and can be shunned
or trimmed? It is almost a cliché to say that
“volatility presents opportunity”, but market
dislocation can bring new ideas into sharper focus.
The long-term political, economic, and financial
repercussions of the “Leave” vote are incalculable
at this point. But markets adapt. Policymakers
adjust. Businesses will change course while they
continue to seek profits. Prices will reset.
Opportunities will emerge. Market volatility
brought on by the UK’s historic Brexit vote is no
excuse to disengage from portfolio planning.
Investors who are willing to look forward, with one
eye on the opportunities and one eye on their
goals, will be more likely to realize both.
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