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Brexit Aftermath: What You Need To Know

June 24, 2016

Yesterday’s vote by the British electorate to end its 43-year membership in the European Union seems to have taken just about everybody by surprise, but the aftermath has been relatively predictable. The uncertainty of how Europe and Britain will manage a complex divorce sent global markets reeling. The FTSE was down more than 11% in USD terms, most of which came from a wild currency swing. The British pound sterling is down significantly--14% against the yen, 10% against the dollar.

Compared to the global markets, the reaction among traders on U.S. exchanges seems muted; down roughly 3.5% as I write this, though nobody knows if that is the extent of the fall or just the beginning.

The important thing to understand is that the real driver of the market volatility so far has arguably not been the immediate economic impact, but the uncertainty that it has introduced. The reality is that Britain accounts for less than 4% of the world’s economic output, which means even an adverse recession there doesn’t really have a significant economic impact on the global economy. 

This breakup will likely be a very long-term, drawn out, and (hopefully) graceful accommodation between the UK and Europe. Yet, the referendum and outcome in the UK may lead to a referendum in other European countries that have been unhappy with their plight in the European Union, which means a new form of ‘European Union breakup contagion’ fear may be taking hold. 

What happens next for Britain and its former partners on the continent? Let us start with what will NOT happen. Unlike other European nations, Britain will not have to start printing a new currency. When the UK entered the EU, it chose to retain the British pound—that that, of course, will continue. Stores and businesses will continue accepting euros.

On the trade and regulatory side, the actual split is still years away. One of the things you might not be hearing in the breathless coverage in the press is that the British electorate’s vote is actually not legally binding. It will not be until and unless the British government formally notifies the European Union of its intention to leave under Article 50 of the Treaty of Lisbon—known as the “exit clause.” If that happens, Article 50 sets forth a two-year period of negotiations between the exiting country and the remaining union. Since British Prime Minister David Cameron has officially resigned his post and called for a new election, that clock probably will not start ticking until the British people decide on their next leader. For the foreseeable future, despite what you read, the UK is still part of the Eurozone.

After notification, negotiations will begin—a new trade relationship, tariffs, how open the UK borders will be for travel, and a variety of hot button immigration issues. Estimates vary, but nobody seems to think the process will take less than five years to complete and current arrangements will stay in place until new ones are agreed upon. 

An alternative that is being widely discussed is a temporary acceptance of an established model—similar to Norway’s. Norway is not an EU member, but it pays EU dues, and has full access to the single market as if it was a member. However, that would require the British to continue paying EU budget dues and accept free movement of workers—which were exactly the provisions that voters rejected in the referendum.

Meanwhile, since the Brexit vote is not legally binding, it is possible that the new government will decide to delay invoking Article 50. Alternatively, Parliament could instruct the prime minister not to invoke Article 50 until the government has had a chance to study further the implications. There could even be a second referendum to undo the first.

The important thing to remember is that markets right now are being driven by emotion to what is perceived as an event. Yet, this is really a long process that will be managed by reasonable people who aren’t interested in damaging their nation’s economic fortunes. Nobody knows exactly how the long-term prospects of Britain, the EU, or American companies doing business across the Atlantic will be impacted by Brexit. This is unchartered territory.

We will continue to monitor the situation and its potential impact on global and euro-area growth prospects. We may change portfolio allocations as warranted. If we do so, we will be sure to notify our clients of the changes and reasoning behind them.

In closing, remember:

  • If you're planning to travel to Europe, celebrate; your vacation just got cheaper. 
  • Bonds and especially managed futures will see a positive response today.
  • It seems likely the Fed will be event more patient in hiking interest rates, which should help markets.
  • Uncertainty and corresponding market volatility will continue in the weeks to come but as long as you're invested in a well-structured portfolio and have exposure to an array of asset classes, you have nothing to fear. Investments are purchased for the long-run. Short-term volatility is normal and expected. As history suggests, market pull-backs most often lead to more positive, long term results.

Stay Disciplined.

Kevin Kroskey, CFP®, MBA

President & Sr. Wealth Advisor | True Wealth Design

June 24th, 2016 

Sources:
https://www.yahoo.com/news/brexit-shows-global-desire-throw-142925862.html
https://www.washingtonpost.com/opinions/global-opinions/after-brexit-what-will-and-wont-happen/2016/06/24/c9f7a2f6-39f1-11e6-8f7c-d4c723a2becb_story.html
http://www.businessinsider.com/global-market-brexit-reaction-2016-6
www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html#ixzz4CVixCz25
http://www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html?ftcamp=traffic/partner/brexit/dianomi/row/auddev#axzz4CVide1Sz
http://www.newser.com/story/227149/brexit-now-what-happens-welcome-to-article-50.html
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