“Very interesting”, is how the Chinese would surmise the market activity over the last 2 weeks. Given that markets have been down roughly 1,000[i] points since the Brexit vote (give or take 100 points, as it’s not worth quibbling about given the recent volatility), I’m electing to move my normal first of the month letter to you up by a few days to address both what we see in the short term (a lot) and what it portends in the long term (also a lot, but different than the negative news everyone in the public press is fixated upon).
Context first; For those who may not know, ‘Brexit’ is the term assigned to the last Thursday British vote (the BR part of the term) of whether the United Kingdom would stay in its current relationship with the European Union or separate from it (EXIT). The vote outcome was a surprise to the popular forecast over the two weeks prior that the British public would find stability (staying) more appealing than the uncertainly of charting new waters (leaving). Alas, it was not to be. By 52% vs. 48%, the leave side prevailed.
Short term result; uncertainty. Markets do not like uncertainty, and thus have naturally plummeted in the last couple of days. The British Prime Minister resigned as he had lobbied for staying. The British Pound is off more than 10%[ii] (keep in mind, Britain was not in ‘full union’ with the European Union and thus the Brits were still using the Pound vs. the Euro). Many politicians, and especially the Brussels politicians (where the EU bureaucrats are based), are wondering what this exit means for the Union and the talk shows are full of prognostications. People seem to forget but the ‘leaving’ will take up to 2 years to negotiate as the Lisbon Treaty (Article 50) will govern the eventual split and terms.
Long term result; uncertain, and certainly messy in the short term, but probably positive. The British are blaming the wrong people (‘them others’) rather than themselves for high housing prices, bad health system waiting lists, etc. (which are totally within their control and have nothing to do with the European Union). On the other hand, the whole European Union has been a 25 year experiment of a Supranational group concept (originally 6 Member states, formally starting with the 1992 Maastricht Treaty, and now at 28) that tried to raise the level of integration of what had heretofore been heightened nationalist tendencies (Brits for the Brits, Germans for Germany, etc.). Again, people forget, but one of the original primary goals of the Union was not simply more economic growth in this region, but tighter integration that would dramatically lessen the likelihood of future wars.
In summary…there is too much yet undecided to accurately predict what this means for worldwide growth, which is the real determinant of equity prices. However, companies are categorically not selling less toothpaste today compared to yesterday, so they are not less profitable or worth less money, but fear is unleashed and market prices are down in fear. That means the current market drops are probably irrational. But longer term what we are seeing is that people do not like long distance career bureaucrats passing law after law when their home town growth prospects seem diminished. For too long economic growth in Europe has been diminished, and people are frustrated with stubbornly high unemployment levels of 8-10%[iii]. The British people simply elected to control more of their own destiny. They will absolutely lose some things in the short term, but hope to obtain more freedom to make decisions in their best interests in the long term.
P.S. I will point out the United States did fundamentally the same thing to Britain on July 4th, 1776. It didn’t work out that badly for us.
[i] Yahoo.Finance.com (June 27, 2016)
[ii] “Sterling Hits 31-year Low On Brexit Vote Aftermath, Euro Slides” (Reuters News, June 27, 2016)
[iii] Unemployment Statistics Explained (Eurostat, April 2016)
