On Thursday the people of the United Kingdom voted in the British Exit Referendum (Brexit) to take United Kingdom out of the European Union to the surprise and disappointment of markets across the globe. The referendum was initiated by parliament and Britain’s Prime Minister, David Cameron, in their attempt to win their elections in 2015. The “leave campaign,” as it is referred to, was motivated chiefly by European immigration and economic policies combined with frustration with the political elite in the U.K. According to Stephanie Flanders, J.P. Morgan’s chief market strategist for the U.K. and Europe, this will be a short-term earthquake politically and economically but should have very little impact on the U.S. economy.
What happens next?
It is important to know that the United Kingdom will not be leaving the European Union overnight. The U.K. is still a member of the E.U. and will remain so for the near future yet the process to leave will begin. Article 50 of the 2009 Lisbon Treaty, which is the formal legal process of withdrawing from the E.U., will not be triggered until after David Cameron, who announced his resignation as Prime Minister this morning, fully resigns from his post in the fall. This process will then take up to two years for the United Kingdom to be removed from the E.U. and until then, Britain will operate under the current policy and trade agreements of the E.U. Negotiations will then begin among the European Union, many other countries around the world, and Britain concerning trade, immigration, data sharing and many other policies.
What is the economic impact and impact on investors?
Dr. David Kelly, J.P. Morgan’s chief global strategist, reminded investors that markets react emotionally over the short-term and act on economic fundamentals over the long term. The Brexit will likely have a negative short-term and intermediate impact on the U.K. and Eurozone economies however have little impact on the U.S. and world economic trajectories. In other words, short-term market reactions that diverge from long-term economic trajectories presents buying opportunities. As the market had not anticipated Britain leaving the E.U., global markets marched higher this past week as confidence grew that the U.K. would remain in the E.U., which makes today’s declines appear more severe.
There are three main reasons to remain positive about the U.S. markets even after the downturn taking place today and the uncertainty surrounding Europe following the British exit from the E.U. The first being that the U.K. is a relatively small player in the global economy making up approximately 4%. Which means any impact on the U.S. economy will likely be minimal. This certainly doesn’t justify a 3% decline in U.S. stocks today. Secondly, with the uncertainty surrounding growth in the Eurozone now, the Federal Reserve will be more likely to leave interest rates unchanged. The Fed has been hinting at a rate hike in the near future but it appears that they will wait until the political confusion following Brexit has subsided. Lastly, the United States along with Japan are being considered safe havens and should attract foreign investment from less stable world economies.
It is important to note that although the U.S. markets are down sharply today, they still remain much higher than the lows from earlier this year. The S&P 500 currently sits about 13% above of the February 2016 intraday low of 1810.10. Market reaction today is an emotional event surrounding the uncertainty of the Eurozone moving forward. As stated above, declining markets likely represent a long-term buying opportunity. Our advice is that investors should remained focused on their long-term investment objectives and goals. If you would like to discuss the Brexit, the economy or your portfolio with us please contact us at (610) 825-3540.