Now that the UK has surprisingly voted to leave the European Union in the so-called ‘Brexit’, what’s next for economies around the globe and the portfolios of individual investors? Even though the exit process for Britain will take more than two years to transition, we saw global stock markets decline precipitously immediately following the vote. The UK FTSE-100 index declined 8.7% during the course of the day following the vote. In just two trading sessions, the S&P 500 dropped 5.4%, with many world indexes tumbling much more. However, two weeks have passed and stock markets have recovered almost all of their losses.
Economically speaking, there are many reasons why the Brexit vote matters to global economies and stock markets around the world. In an economic sense, the general thinking is that a vote by Britain to succeed from the EU could be bad for international companies. This is because many international firms, including many based in the US and China, invest in their U.K. operations so that they are able to access the free-trade corridors that the U.K. enjoys with the rest of the EU. As such, the sudden need to reset numerous investment channels may have a freezing effect on the whole region, resulting in many of these companies seeing drastically reduced profits. This could potentially derail what has been a fledgling global economic recovery at best.
In the US, nearly a third of sales that firms make in Europe are executed by their British subsidiaries, which tend to be their European headquarters. Other large European cities like Paris, Frankfurt, Berlin and Amsterdam run fairly far behind when it comes to establishing a European toehold for US firms. Now that Britain has left the EU, US companies (and those around the world) will have to increase their costs and restructure their resources to maintain their access the EU and Britain. This is why we saw such a large pull-back in global stock markets around the world immediately after Brexit: stock markets don’t like uncertainty, and the Brexit vote was a gigantic vote of uncertainty. The International Monetary Fund made the following statement back in April regarding a possible UK exit from the EU:
“Negotiations on post-exit arrangements would likely be protracted, resulting in an extended period of heightened uncertainty that could weigh heavily on confidence and investment, all the while increasing financial market volatility. A U.K. exit from Europe’s single market would also likely disrupt and reduce mutual trade and financial flows, curtailing key benefits from economic cooperation and integration, such as those resulting from economies of scale and efficient specialization.”
So what about individual investors? How should long-term investment portfolio’s be adjusted to reflect this new level of uncertainty? For individuals with a shorter time frame, say 1 to 3 years, their investments should be not heavily stock-market orientated, so the Brexit situation should be a non-event. Investors with a longer-term time frame, say 3-10 years (most retirement portfolio’s), a slight decrease in equity holdings may be warranted. Given the seemingly relentless increase in global stocks over the past 7 years and many equity valuation measures hovering above long-term levels, a slight decrease (5 to 10 percent) may seem like an obvious move for the astute investor.
The following article from writer Alison Schrager at Quartz outlines many investment themes individuals should use when markets possibly ‘over-react’ immediately to potentially bad economic news (as in the days immediately following Brexit). Entitled “What Brexit Means for Your Investment Portfolio”, the article highlights some important points when investing in shaky markets. Staying global and realizing that the world is a riskier place are two of the more important ones.