Last Thursday, British citizens voted to leave the European Union. On Friday and today, various national stock market s declined in value, as they typically do after events that cause uncertainty. This post will discuss short and long term ramifications for U.S. investors.
What Happened? Before looking forward, let’s look at the past couple of days. While everyone knew the vote was coming, the vast majority of political and economic analysts believed that the U.K. would choose to remain in the E.U. Indeed, prediction markets (allowing individuals to wager on the outcome of the referendum), currency prices for the British pound, and stock markets rose throughout the week on anticipation of the “remain” outcome. That is one reason the decline on Friday was as large as it was.
Our view, at least as it pertains to U.S. stock markets, is the decline in Friday’s and today’s stock market is an overreaction, even considering the uncertainty. We say this for three reasons. First, the specifics of how much this will impact the British economy are far from certain. It is in Britain’s best interest to build individual trading agreements with countries (just as the U.S. has done), which, in their total, may end up having a similar nature to the overall E.U. So while the impact could, in theory, be highly restrictive for British trade, the likely outcome will be far less severe. Second, we need to focus on the scale of magnitude. The U.K. economy makes up a total of less than 4% of global GDP. So a decline of 4% by U.S. stocks implies a) the U.K. economy will be totally wiped out and b) the impact of such a disaster will be felt as equally in the U.S. as it will elsewhere around the world. Neither of those possibilities is close to being accurate.
Our third reason is perhaps the most important. The view that the U.S. would be hurt assumes a general view that world economies are linked, and a falling tide causes all boats to drop. However, the U.S. is also a competitor in the world market. If indeed the impact on U.K. – Europe trade is severe, it is likely that a large number of U.S. businesses will benefit as a result of replacing those trade partners for both the U.K. and Europe. If a French manufacturer can no longer efficiently buy parts from a British company, it is likely that a U.S. supplier will fill the void.
What Will Happen We can use similar events in the past to help guide us about what the future will be. In 2011, we commented on the Greek Debt crisis. Last year, we described the decline of the Chinese Yuan. And in January of this year, we analyzed the impact of low energy prices. In all of those cases, our analysis was that the market reaction was likely overstated, and investors would be better off maintaining their position in equities than selling off after a market decline. And in all of those cases, the results substantiated our analysis. Indeed, I’ve been in New York City Friday and today (on a long-planned trip) meeting with various equity managers, and the general consensus is that there are plenty of buying opportunities. Because of the results of past events like this, and because of our analysis we described above, as a long-term investor, our recommendation is that you continue your overall allocation.