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Jul
18
2016

Britain's Exit From The European Union

On Thursday June 23, 2016, British citizens shocked the world by voting to leave the European Union upending 43 years of participation in the attempt at economic solidarity. The intermediate and long-term economic repercussions of this political vote are yet to be fully understood; however, as evidenced by global markets’ reaction we will likely continue to experience heightened volatility and destabilizing uncertainty.

Around the world markets fell by as much as 8% as news broke as to the results of the referendum, in the United States most indexes fell by 3-5% in early trading. We have typically recommended clients attempt to avoid being overly focused on headlines while turning attention to the progress in the fundamental underpinnings of the U.S. and global economies. We believe that in the long-term markets will follow those fundamentals while in the short-term they may deviate materially on a day-to-day basis. It is worthwhile noting that the day prior to the vote the Dow Jones Industrial Average rallied 230 points in anticipation of a “stay” vote. So to see the market down 500 points at the open is not quite as jarring as one may have originally suspected when only looking at the singular day’s movement.

The past 2 years has been fraught with challenges and confusion regarding global interest rate environments, debt issues in Europe, falling oil prices, geo-political unrest, concerns around China’s growth and the list goes on. However, I would urge our long-term investors to reflect on our world’s prior decades. There have always been reasons and excuses to avoid investing, generally to the detriment of long-term performance.

Markets are emotional beasts that can flail in the face of uncertainty. They have the potential to surprise us to the downside as well as the upside. The difficulty in navigating choppy directionless markets stems from the fact that emotion tends to drive trading rather than facts and data. With that in mind, we would suggest a brief thought experiment: As markets opened they were trading down about 3% for the S & P 500. Is there any reason to suspect that the fundamental value of the great companies of The United States of America should have lost 3% of their value overnight because Britain no longer wants to be tied to the European Union? Most would agree that this vote should have little long-term impact on how profitable our corporations will be in the United States. Corporations have historically shown tremendous ability to innovate and remain profitable regardless of political changes throughout the world. We support the idea that this will continue to be the case.

Obviously, in today’s globalized market environment there is greater correlation between asset classes, particularly during periods of heightened turmoil. However, it’s important to take stock of what will follow this referendum:

We believe there is a potential that this vote may cause a cascading effect of other EU nations participating in similar votes. We remain on guard for this effect. Additionally, bear in mind that the vote is not binding. While it would be hard to imagine the British democratic system completely disregarding the will of the people; the true process of leaving the European Union will be protracted and bumpy. The initial target would not earmark the exit for at least 2 years during which time there will be many negotiations between Britain and the European Union regarding how that exit will be facilitated formally. During this time, there will be many opportunities as well as challenges.

The macroeconomic impact in the near term may result in a strengthening U.S. Dollar as capital flows to the relative security of U.S. markets and securities. This can put downward pressure on already low interest rates. Additionally, this will make our exports less attractive because they will be relatively more expensive for the rest of the world. The net effect will be short-term disruption to large multi-national corporations’ profits. The Federal Reserve may extend the duration of time before they resume their interest rate hikes; however, the short-term volatility in our markets may be outweighed by the marked strengthening in the U.S. labor markets. Therefore, it is possible that the pause in interest rate hikes would be temporary. In the end, as new data emerges and changes we will continue to incorporate those viewpoints into our investment philosophy.

Allied Financial Services stands prepared to discuss the implications of this decision and the consequences for your long-term investments. If you would like to the opportunity to explore your objectives more thoroughly please contact us! We welcome your thoughts and look forward to helping you continue to navigate this tumultuous market environment.

David A. Younis, CFP®
Director of Financial Services

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