Brexit – What does it mean?

Yesterday was a historic day for the United Kingdom (U.K.) and Europe, as British citizens voted to leave the European Union (EU), otherwise known as “Brexit”.  There has been heightened volatility across markets in the weeks leading up to the vote due to the uncertainty and no clear direction of this historic vote.  In fact, polling yesterday as of late afternoon were in favor of remaining in the EU while markets this week recouped much of losses sustained in June as expectations for Britain to remain part of the EU were high.

Below is a detailed chart of all of the issues at stake.  In summary, the key to this vote was a continuation of status quo if Britain remained in the EU.  This would have resulted in a continuation of market appreciation experienced over the past week, both here in the US and across international markets. However, the vote to leave the EU, or Brexit, has resulted in a volatile reaction to the downside for equities in both US and international markets.  It also resulted in a sharp selloff of the British pound and a flight to quality, strengthening the US Dollar and further pushing down bond yields beyond their recent historic lows in both government and corporate bond markets.

Source: Global Counsel

But why would Britain want to leave the EU? Advocates of a Brexit pointed to the increasing cost of membership to stay in the EU, which has been steadily rising since the financial crisis.  Further economic troubles with countries like Greece may continue to increase costs to remain in the EU.  Another major issue is with immigration, as by law, Britain cannot prevent anyone from another EU country from coming into the country.  Consequently, the country has seen a massive immigration from weaker areas of the EU, such as Greece and Portugal.  The influx of workers has made it more competitive for UK citizens to find jobs and increase wages.  This was a major sticking point for many working-class British citizens.

Remaining in the EU would have allowed Britain continued access to European markets for trade and manufacturing without any barriers to entry or increased regulations.  The EU is their major trading partner, accounting for 44% of exports and 53% of imports of goods and services in 2015 (source: UK House of Commons Library Briefing Paper dated 6/13/16).  Leaving the EU may result in rising costs for businesses due to increased regulations and barriers to entry to sell goods. This may also reduce foreign investment in the UK, which is used as a gateway to Europe by major trading partners, such as the US, China and India.

The impact of a Brexit vote may not be immediately known until terms are settled between the UK and the EU.  There are many potential outcomes, however this is a process that may take years to sort itself out.  Although this negative outcome has created volatility in the near term, we still believe in the long term positive fundamentals of equities both here in the US and abroad given the strength of the US economy.  We believed it was prudent to take a cautious approach to putting cash to work in the current environment until the vote was finalized.  We will continue to monitor the situation and will use this period of market volatility to invest cash into our portfolios.