Bear Mountain Capital Inc.

The Brexit and What It Means

| June 24, 2016




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Yesterday, the United Kingdom voted to leave the European Union. While a close vote was highly anticipated, the markets had discounted the possibility of a “Brexit” the last several days by pushing the markets upward. After the final results came out last night, the markets had to reverse course. The “Leave” group had voted 51.9% in favor of leaving the union.

Unsurprisingly, the result was a big sell-off today across many equity markets. The biggest asset class affected was international developed equities. US equities also realized a big decline, with the Dow Jones Industrial Average selling off 611 points or -3.39%. Meanwhile, US and international high-quality bonds posted positive gains.

Market Volatility

The graph below shows the market activity over the last month. The blue line is the Dow Jones Industrial Average (the Dow), orange is international large cap stocks represented by the Vanguard FTSE Developed Markets ETF (VEA), red and green or US and international bonds (BND and BNDX), respectively.

Volatility has been in play all month in anticipation of yesterday’s vote. As mentioned above, in the days leading up to the vote, the US and international markets had priced in a “Remain” victory. In the end, however, “Leave” won out and a sharp decline on the right side of the graph reflects today’s sell-off in equities, while safer assets, like bonds, gained.

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The next graph depicts the same asset classes but over the course of the last 12 months. Here you can see a steady rise in bond returns. However, global equities have been grinding through significant volatility all year. Both international and US equities are still above their 1 year lows.

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What Does It Mean?

The United Kingdom leaving the European Union is a big surprise to many. Many Britons woke-up shocked to the news they were no longer going to be members of the union. As many grapple with the results, answers to questions about timing of their departure and other details remain unclear. It may take as long as two years to complete the process.

The repercussions of this vote include a significant hit to the currency. The British pound traded at $1.32, near a 30 year low, in the hours after the vote. In addition, the UK may have to deal with a revived independence vote from Scotland as most Scots voted in favor of staying in the EU. If Scots are no longer privy to the EU, their desire to stay with Britain will certainly be up for discussion.

Many speculate Britain’s departure means certain recession for the UK and maybe the larger Euro region. Nearly half of Britain’s exports go to the EU. In turn, the EU relies heavily on British spending. When trade deals have to be renegotiated, and they will be, the terms of these deals will have an unclear impact on business activity in both regions. What is clear is there will be a drag on the economic relationship between Britain and the EU. The extent of this drag will not be known for sometime.

As we’ve discussed many times, investors and the markets-at-large do not like uncertainty. Until the terms of UK’s exit are negotiated, uncertainty will reign. As time passes and details emerge the volatility will settle out. Over the long-term many investors will re-calibrate their expectations about growth in Europe and the impact on other markets.

What Should I Do?

At times likes these emotions are high and fear of losses drive many investors out of the markets. However, a decision to sell to avoid near-term volatility forces you to make a second decision: when to get back-in? Often, it is the second decision that investors do not think about nor anticipate when managing their investments.

Experience tells us how important it is to stay the course through difficult, uncertain times. Timing the markets on the downside (or upside for that matter), is a long-term losing proposition. Markets are fickle and volatile by nature. At times like these, a decision to do nothing and stay the course is still a decision, and usually the correct one.