Brexit Market Commentary
June 29, 2016
England’s decision to abandon the European Union will rank among the most seismic geopolitical events of our time. While we were surprised that the “Leave” faction prevailed in Friday’s referendum we were nonetheless prepared for it. While we would not underestimate Brexit’s significance as a rejection of the very neo-liberal free market capitalism order that we support, we do not believe that the dire reactions and predictions that followed the rejection are entirely justified given the vast uncertainty that now confronts us.
The triumph of “Brexit” was only the first step in what will be a long and complex journey, the consequences of which will reveal themselves slowly and perhaps even subtlety over time. We will consider this process as it unfolds just as we do other matters of concern in both developed and emerging markets but we will not leverage for short-term gain an issue that is driven more by political impulses than economic ones. For now we will watch and wait and we would advise others to do the same.
In anticipation of further market turmoil – London’s 10-year borrowing cost fell below 1% on Monday for the first time and sterling tumbled to a 31-year low against the dollar – the International Monetary Fund smartly assured it would support the Bank of England if such assistance was needed. A period of instability following a disengagement of this scale was to be expected. Certainly we anticipated the worst back in February; concerned about a host of global developments including “eurozone political concerns [that] may negatively affect growth,” and we built up a cash reserve, as applicable by model, by downsizing positions in Europe and Asia. We’ve been underweight ever since and that’s where we intend to stay as we sift through a thicket of trends and indicators, including:
- Whether England’s large current account deficit, now at its highest level since 1948, will hobble the pound’s recovery. If so, will London be forced to cut spending in what could be sustained and painful inflation?
- What will be the impact of the decision by Moody’s and Standard & Poor’s to downgrade England’s credit rating?
- To sustain their lifeline to EU markets, will the major investment banks realize their contingency plans to move parts of their operations – particularly those that trade euro-denominated assets – to continental Europe?
- Will labor mobility, a defining EU principal, become a victim of Britain’s withdrawal? Will multinationals need to provide visas for their non-English employees?
- Will immigrants flood Britain before withdrawal is finalized and the country effectively locks its doors to those seeking asylum or better working condition? If so could this cause political instability?
- How long will the divorce take? Outgoing British Prime Minister David Cameron signaled last week that he was in no hurry to begin a process that could take years. Though former London mayor and Brexit enthusiast Boris Johnson would certainly demand a compressed timeline, should he succeed Cameron as many observers anticipate.
- Will the leaders of Germany and France, the heart and soul of united Europe, outmaneuver Brexit copycat movements throughout the continent by insisting that the UE become more democratic and responsive, reduce red tape and create a eurozone finance minister?
This is only a short list of the “known” unknowns that now bedevil the world’s political and economic elites; no doubt other tactical and strategic crises will present themselves as Europe picks its way through the rubble left by last week’s events. Rest assured we will evaluate their significance as closely as we will other worrisome trends – China’s vertiginous debt, for example, or the Federal Reserve’s meandering monetary policy. Given such an abundance of potential flashpoints there can surely be no more valuable a set of commodities than restraint, patience and perspective.
Sincerely, David Young, CFA
Chief Investment Officer
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