The Brexit


    As I write this at 9 PM on Thursday night, it is looking like Britain could be leaving the European Union. They are still tabulating the results of today’s UK nonbinding referendum results, and with about 2/3 of the precincts reporting, those voters favoring “leaving” the EU constitute about 52% of the electorate, while those favoring “staying” in the EU make up about 48%. If these results continue to hold throughout tonight, Britain may indeed be leaving the European Union, a move nicknamed “Brexit.” The major TV networks have now determined that “Leave” will indeed win.

    How and when Britain will leave, and under what conditions, are completely unknown at this point. This has never happened before, so undoubtedly the nuts and bolts will need to be worked out.

    As you might imagine, this is turning into a big shock to the global financial markets, because they had been assuming the vote would end up in favor of staying. In fact, in recent days, we’ve seen very strong stock market performance based on these expectations.  As a result of the surprising election results, stock markets around the world are down sharply tonight. The Dow futures are down about 600 points (3.6%), and the S&P 500 and NASDAQ futures are down about 4.5%, indicating a dramatically lower open tomorrow morning in New York.

    To give you the background on this issue, the European Union is a political and economic union of 28 member states located in Europe, and covering approximately 500 million citizens. It is a hybrid system of laws that created a single market that ensures the free movement of people, goods, services, and capital. All passport controls between the EU countries have been abolished. Nineteen of the member nations share the same currency, the Euro. Britain is not one of those nineteen, having decided to stick with the pound.

    In many ways, the EU functions similar to how the states relate to each other in the United States. And therein lies the biggest problem. Because people can move freely between the member countries, that has meant that Britain has been the recipient of millions of immigrants from Eastern Europe in recent years. There have been English villages and towns that have ballooned in size as a result of these immigrants, and that has caused the very character of the towns to shift toward being more like towns in Poland, for example.

    These changes have caused many Britons to become fearful and resentful of what they see as the EU forcing unwelcome immigration policies on them, and these strong feelings have helped fuel today’s vote to leave the EU. This is a vote for British self-government and the right to determine their own way of life as much as anything else. A lot of pretty strong tactics were used to try to convince the Brits to stay in the EU, including threats of dire economic consequences. President Obama famously told the nation they would, “Move to the back of the queue,” if they left the EU. But the ever-scrappy Brits seem to be saying, “Fine, we’ll take the consequences in exchange for being able to retain the character of our nation.”

    What does this mean for us as investors?  Certainly we are going to see sharply lower stock markets worldwide on Friday. This does not look like the beginning of another cataclysm in the markets however. Whenever the markets run into an unexpected shock like this, they react by moving sharply lower. Events like this are known as Black Swans, because they are extremely rare. It is going to take a while to sort out what the effects will actually be on the British pound, currently down from $1.50 to $1.36, the Euro, also down very sharply against the dollar, and the British economy.

    Our take is this will not have long-lasting consequences on the financial markets. Remember back in recent years when Greece seemed poised to leave the Euro in what was then known as “Grexit?” If they had left, does anyone think their departure would still be affecting the markets today?

    To us, this so-called Black Swan event will only turn out to be an opportunity to buy stocks at suddenly lower prices. We will be looking for opportunities to do just that all day tomorrow.

    I’ve been an investment advisor for 31 years now, and during that time the S&P 500 has increased 25-fold, while small cap stocks have increased 41-fold during that same time. And this has happened despite two 50% market crashes, one 22% stock market crash in a single day (in 1987), several recessions, and countless market corrections during those same 31 years.

    This is a great day to be like the Brits, and keep a stiff upper lip. This too will pass, and it’s certainly not a day to be selling for long-term investors.