“I think this is probably the worst self-inflicted policy wound that a country has done since the Second World War.”
No doubt you will have heard that the United Kingdom (UK) will exit the European Union (EU) after yesterday's 52% to 48% vote in favor of Brexit. The full ramifications of this event are hard to predict, but it is clear that they will be negative, large in magnitude, and will affect the trajectory of Europe over the coming years and decades. Global investors reacted accordingly, sharply driving down risk assets like equities and commodities, and driving up safe haven assets like US and Japanese government bonds. The UK equity market was down about 12% in US$-terms while the S&P 5001,2 was down 3.6%. On the spectrum of conservative to aggressive, AlphaGlider strategies were off between 2% and 6% on the day.
Over the coming days I will be digesting the implications of Brexit in order to decide how it should impact the positioning of our AlphaGlider strategies. The inevitable economic slowdown caused by the messy divorce between the EU and its second largest member (and the likely follow-on exit of pro-EU Scotland from the UK) comes at a difficult time—global growth is stagnant and central banks have run out of options to stimulate it. Brexit could be the trigger for the next global recession.
More concerning to me, however, is the root cause of the Brexit vote—the rising populist anger that has grown out of the frustration of those negatively affected by technology, globalization, and immigration. The sense of disenfranchisement is hardly unique to these 52% of British voters. We are seeing this same anger in the US among supporters of Bernie Sanders and Donald Trump. We are seeing it in voters across many countries in continental Europe, most notably France, the Netherlands, Austria, Denmark, Finland, Norway, Switzerland, Hungary, Latvia, Lithuania, Slovakia, Poland, Greece, Italy, and Spain.
It is imperative for the economic and political elite in the developed world to address the issues behind the rising populist anger, otherwise we are likely to see more countries disengage from the global economy and adopt isolationist foreign policies. We only need to look at Trump's threat to apply 45% tariffs on Chinese imports and 35% tariffs on Mexican imports (the US's 3rd & 4th largest trade partners after the EU & Canada), and to pull back military resources and support from NATO, Japan, and Korea should he be elected, to see the threat to global trade and stability from the rising tide of populist leaders. Lost in the discussion of the Brexit is why the EU was created in the first place—to make Europe so interdependent economically that war amongst its members wouldn't break out again like it did in WWI and WWII. Although the EU has its flaws, it has been very successful in keeping the peace.
Today's sell-off was painful, but it is important to keep a calm and reasoned disposition in times like these. Negative news and their accompanying sell-offs are unfortunately a fairly common occurrence. For the UK's main equity index, the FTSE 100, 3 today's sell-off was only its 9th worst day over the last 30 years.
Source: The Financial Times
Over my 20-year career in the markets I've gone through the '97 Asian currency crisis, the '98 Russian debt crisis, the bursting of the dotcom bubble, 9/11, wars in Iraq and Afghanistan, the '08/'09 global recession, multiple Euro currency crises, and the Russian invasion of Crimea. Each one was painful, but rarely was it prudent to have sold during the depths of these events—usually because valuations either fairly reflected the new realities or overshot them to the downside (the cheap side). Indeed, the 15-20% fall in UK and European stocks over the last 12-months go a long way toward pricing in today's negative news.
Perhaps Brexit will spur the EU to address its structural issues and EU governments to increase much needed fiscal stimulus. Perhaps the markets' damage from the Brexit will discourage other EU countries from planning their own EU exit. Likewise, perhaps US voters will take the Brexit lesson to mind when they go to the polls in November. Perhaps Brexit will be the call to action for the western economic and political elite to enact policies that more equal distributes the wealth generated from global trade. These are all upside scenarios that are not being priced in to the European markets currently.