Brexit Is A Big Deal

6/26/2016 – Brexit “Black Friday” cost investors over $2 trillion in market wealth (CNBC) as global stocks fell -5.4%. Here in the U.S., the S&P 500 was down -3.60% and in Europe, the STOXX 50 was down -8.62%.

markets 6-24-16
Brexit was largely considered an unforeseen event, a black swan event perhaps. I personally believe it is the largest financial shock since the 2008-09 financial crisis. Will this lead the markets down further? Nobody knows for sure, but the odds of a market selloff have certainly increased. Though, Brexit is not the only stressor on the global markets (e.g. tepid global growth, high stock valuations, declining corporate earnings, etc.). I have been talking about these stressors for quite some time now. See previous posts here, here, and here
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Brexit: Why It’s A Big Deal

The United Kingdom is the 5th largest economy in the world, behind only the U.S., China, Japan, and Germany. (World Bank) No doubt about it, the UK leaving the European Union is a major geopolitical event. This is the first time since WWII that Europe has suffered a major decrease in it’s economic alliance with each other. And this is happening in a region that is already plagued by slow growth. The Bank of England said on Friday morning, “We are well prepared for this.” It will likely cut its main interest rate (currently 0.5%) and even revive its quantitative easing efforts. Nonetheless, a recession in England certainly seems likely. 

Because an event like this has never happened before, the fallout is extremely difficult to forecast. Though, here is my attempt to see how it will affect the UK: 

  • UK corporate investment will slow due to the uncertainty of the future between the UK and EU. The UK has participated on trade deals which have been negotiated by the EU. The future of those deals is now in question. 
  • Consumer spending will slow as recession fears mount and as the British pound collapses. The collapsing pound might also drive up inflation, which would also hurt real income rates. 
  • The UK unemployment rate will also grow as companies seek to limit spending and to shore up balance sheets. 
  • The European economy will also likely slow, possibly contracting into negative rates as the EU copes with a departing UK. Though, the reduction in GDP growth will likely not be as severe as the UK. 

How the rest of the world will be impacted by a Brexit is much more complicated. The world economy is already fragile, so the risks are real. Here is my guess as to how things might play out: 

  • Southern European countries will see bond spreads rise as the risk for further EU exits mount. 
  • A weaker Europe will hurt Chinese exports as European currencies weaken and as consumer demand softens. 
  • The Chinese Yuan will likely fall in anticipation of this new possibility. 
  • The U.S. Dollar will strengthen on weakening European and Chinese currencies and on the falling probability of a Federal Reserve interest rate hike. 
  • Oil prices will likely feel downward pressure on lower demand and a stronger dollar. 

Because there is so much uncertainty regarding the future of the UK and the EU, market volatility will certainly remain high. How quickly the UK and the EU negotiates a trade deal will help alleviate market concern and volatility. If a deal is passed relatively quickly, the damage can be (theoretically) minimized. However, the markets on Friday have indicated that this might not be the case. Furthermore, if Britain is able to execute a favorable trade agreement in a short amount of time, might not other countries in the EU likely attempt to do the same?  And isn’t this what the EU hopes doesn’t happen?

Elected Officials: Wake-Up Call

More than anything, Brexit should be seen as a wake-up call to all western elected officials. Rising inequality and low growth promotes frustration among its citizens. Brexit represents the division between the politician’s hopes for what the majority of people should do and what the majority of people are willing to do. So far, central bank intervention (e.g. U.S. Federal Reserve, European Central Bank, etc.) has been the primary driver of economic growth. There has been little, if any, positive contribution from elected officials. This, or course, is not sustainable. Politicians need to take the necessary steps to promote higher growth. And these steps should include the majority of its people, not just a selected segment. Otherwise, similar (and seemingly improbable) events like Brexit are sure to occur again. 

How My Clients Fared

As a litmus test to see how well my clients performed on Friday, I compared the three Bull Oak strategies returns versus the major benchmarks:

6-26-16 daily return
While I cannot control the markets nor their returns, I can control how my clients participate. Bull Oak clients can rest assured that their portfolios are well positioned in this environment and that I will continue to make the necessary changes as economic changes occur. 

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
6/26/2016


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While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.