Quarterly Letter to Clients - July 2016
Markets don’t like uncertainty. That old adage has been used often to explain stock price declines in some of this year’s trading sessions. The referendum vote in Britain to leave the European Union added another ingredient to market psychology: a bad economic surprise. As Jason Zweig wrote in The Wall Street Journal, “Investors hate uncertainty, but they despise surprise.”
The British referendum (Brexit) on leaving the European Union (EU) had both. Most observers had been predicting a likely voter preference to remain a member. As a result, U.S. stock prices were strong the day voting was taking place, with the Dow Jones Industrial Average up 230 points. When the voting outcome was known, prices plummeted for two days, and the Dow declined 870. Divisions of opinion within Britain about Brexit were unusual, and substantial. Young voters were overwhelmingly in favor of staying in the European Union, while their elders wanted exit; residents of London and other cities favored staying by a wide margin, while those in outlying areas wanted out. There were strong feelings on either side of the issue, and considerable bitterness remains.
Since its founding in 1993, the EU has been a powerful and positive force for European economic growth, although in recent years, there has been increasing discord among members. How to deal with immigration has been an emotional and divisive issue, as it has been in this country, and the steps taken to assist EU members with weaker economies have caused additional friction.
Most of those who voted for Brexit probably were surprised by the extremely negative reaction of equity markets around the world, nor did they recognize the troubling repercussions likely for their own economy. Most economists now expect difficult days ahead for Britain. Comments from Barclays are representative: “We expect at a minimum a minor recession in the U.K. and significant slowing of euro area growth in the year ahead.” This worsening outlook led both Standard and Poor and Fitch to lower their UK credit ratings. Chances of turning around the Brexit vote, either through another referendum or act of Parliament, seem slim, so uncertainty regarding the full impact is likely to continue for some time.
Near term, U.S. growth should be affected very little since Britain is only our seventh largest trading partner. If other countries leave the Union, however, or if the British action has greater-than-expected negative impact on the rest of the world, the U.S. may feel more of an effect than is now expected. And while the Brexit surprise is behind us, uncertainty remains. It is not a time, we believe, to leave common stocks, but rather a time when financial strength, growth and dividends should be emphasized even more than usual in an investment portfolio.
Enjoy your summer – and don’t let Brexit or the upcoming election get under your skin!