June 25, 2016
Much to the market’s surprise (and ours as well), a slight majority of British voters braved the rain and mandated the decoupling of Britain from the EU. Britain was always a loose EU affiliate as it joined reluctantly and has always maintained its own currency. Truth told, in many ways, the defiant Brits made strange bedfellows within the EU. Imagine the United States as an EU member. Taken a step further, imagine how a stay/leave the USA vote might turn out if offered to the citizens of Tennessee. Not only would Tennessee likely ditch the EU, it might opt to secede from the Beltway Class in DC as well…it has happened before after-all. Currently, 37% of Tennesseans approve of President Obama and 15% approve of Congress. Those numbers are far beneath the 44% EU approval rating within the UK. In other words, the Brits like EU governance more than Tennesseans like our own Federal governance. Frankly, the political gamesmanship between Cameron and the EU that led to the balloting was a mistake and one that reflects the arrogance of the superstructure. But, the eggs cannot be unscrambled and the ascertainable results will take years to assess. In the short run, everyone nearby loses economically. Business decisions rely on confidence, and high levels of uncertainty historically correspond with low levels of investment in people, property, plant and equipment. Furthermore, as the rules change, the economics change, meaning existing people, property, plant and equipment may require repurposing and relocation to maximize output. This reshuffling of the deck will require time and money. Concurrently, it’s now open season for emboldened candidates and political strategies. The “Make America Great Again” parallels cannot be denied. The Irish are rumbling about reunification, the Scots apparently like the EU more than the Brits, the Dutch and French are growing ever more obstinate and the EU itself has to decide whether to punish, patronize or pardon the UK for its defiance. Hyper-political environments confuse economic actors meaning that the economic impact of Brexit will depend largely on the capacities of global politicians to “keep the peace.” I wish I knew how to build a spreadsheet for that!
Mathematically, the Brits departure is less worrisome. The UK economy represents 4% of the global economy. Trade between the US and the UK accounts for less than .5% of the US economy. A slowdown in the UK while it redrafts contracts, will not lead to a global recession. Although Friday’s market reaction seemed severe, it was much more muted than the reaction to the Chinese devaluation last fall. Furthermore, the markets rallied significantly ahead of the vote. For the week, the UK FTSE stock index actually made money in pounds and the Eurozone Stock Index advanced in euros. The US markets lost about a percent and a half, and 10-year bond yields fell to 1.57% from 1.65%. I am not minimizing Friday’s action, I am just widening the aperture to provide more sober context.
From here…and you know what I am getting ready to say…it’s all about the US dollar. Should the “fear” trade lead to renewed dollar strength, our bullish thesis will fail. Should the Fed work diligently and effectively to restrain the dollar, then markets can rally despite pugilant politics.
Bottom Line: The Brexit vote will alter political discourse and suppress economic animal instincts to a degree. However, a potential self-inflicted recession in Britain need not spread worldwide. The actual UK/EU disentanglement process will take time. Companies and economies will overcome Brexit and media consumers will flip to a new fear. The political forces beneath Brexit are far more significant. Britain left primarily over immigration angst (see graphic above). Trumps popularity cites the same source. A larger than assumed population of global citizens feels marginalized by globalization, threatened by immigration, and neglected by their own political institutions. In this vein, Brexit should be rebranded as Un-Occupy Europe as it closely related to Occupy Hong Kong, Occupy Wall Street, and the populist Trump/Sanders campaigns to Occupy White House. We believe markets will gather themselves ahead of, or during, the upcoming earnings season as corporations remind us of their skill and adaptability. As to the political theatre at home and abroad…well…we hope you enjoy tragicomedy.
Have a great weekend!
David S. Waddell
CEO, Chief Investment Strategist
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