June 2016
The UK Referendum: Brexit Wounds
www.theguardian.com
This morning, the world awoke to discover the historic results of yesterday’s referendum in the UK: Britain has voted to leave the European Union. This is, without a doubt, a monumental event, and as such, we wanted to put together an interim commentary describing what the likely market impacts are, and outlining what to expect moving forward.
Breakdown of the Vote
The vote itself took place yesterday in the UK, with a massive 72% voter turn-out rate for the voting locations of Scotland, England, Wales and Northern Ireland; and, despite most recent polls leading into the vote suggesting a ‘Remain’ decision, the ‘Leave’ vote prevailed with approximately 52% of the vote, as outlined in the graphic above.
As is custom, the demographics of the voting decision displayed a stark contrast of profiles, with those who are more educated, higher income earners, younger or immigrants more likely to vote ‘Remain’. On the other side, those less educated, native to the UK, older, or earning low wages, tended to vote ‘Leave’. Individuals residing within larger cities also tended to favour remaining within the EU. This result cannot help but be compared to the current political landscape in the US, where we see signs of a working class that is vocally concerned about their current situation and is yearning for a solution.
What’s Happening Now
The most important thing to note about this referendum is that any concrete impact will take time to be implemented; today’s result was merely an opinion poll, and the UK will remain part of the EU for approximately the next two years while they facilitate the process of leaving. However, there have been immediate impacts that are important to note.
Prime Minister David Cameron has stated his intention to resign by the fall, stating “The British people have made a very clear decision to take a different path, and as such I think the country requires fresh leadership.” Cameron has been vocal of his preference to remain within the EU, and as such, this result was expected. As the figurehead of the ‘Leave’ campaign, ex-London Mayor Boris Johnson is the current leading candidate to replace Cameron as Prime Minister, with the next most popular candidates being Conservative Party politician Theresa May or Conservative MP Michael Gove.
In terms of the financial markets, the initial effect has been the expected reaction to emerging uncertainty, with stock markets falling, ‘safe haven assets’ surging, and volatility increasing. Most international stock markets dropped this morning, losing $2 trillion of wealth cumulatively worldwide. Markets in France, Germany and Italy each fell 6% – 8%, while England’s stock market fell only 2%. Gold bullion rose nearly 5%, with the US Treasury yield falling to its lowest since 2012, at approximately 1.5%; both of these assets are typically seen as ‘safe havens’ and stores of value, and tend to benefit from uncertainty. Moments such as this are a potent reminder of why we are proponents of holding precious metals exposure as portfolio insurance. The Great British Pound has lost approximately 8% relative to the USD, and the VIX Volatility Index surged 37%.
What’s Next?
As mentioned previously, the Brexit vote merely represents the beginning of the process, rather than the end of it. No country has ever left the European Union, and as such, there is very little precedent to go off, and the anticipated time frame is approximately 2 years for a resolution to be concrete. Terms and relationships will need to be negotiated, and another vote will likely need to be put to the British people. The priority of the discussions will be the terms of Britain leaving the nation bloc, as well as new trade contracts with the combined market, proposed regulations, and border migration. In order to maintain the current level of access to the Eurozone, in terms of trade, it is expected the British borders will have to remain ‘open’ to those with EU passports.
The economic impact at this point is uncertain, however, many believe that the Brexit will have negative effects on the British economy; the UK government itself estimated that the British economy could be between 3.8 and 7.5% smaller by 2030, and other independent economists have even lower estimates. The primary expected negative effects would be symptoms of lower foreign investment and corporate activity, and the severity of any impact will be dependent on the eventual deals that are negotiated with the EU. Critics of the Brexit are pessimistic of trade deals an independent Britain will be able to achieve, stating their opinion that the EU has an incentive to take a hard line in negotiations, in order to dissuade other nations from leaving the bloc. Movements to separate from the EU within Spain and France, most notably, have gained popularity recently, and if they were to do so it would likely spell the end of the EU. ‘Remain’ voters fear that Britain will be used as an example in this scenario.
Despite being part of the Brexit vote, Scotland, Northern Ireland and Wales are expected to have their own votes in the near future, in order to decide whether to remain as part of the UK or to stay within the EU themselves.
How will this Affect Canada?
Unless you are a dual-citizen, the UK vote will likely have little direct impact on Canadians; however, there are some speculated effects on our Canadian economy to consider.
The first is the effect on trade. Canada recently established a trade deal with the EU, referred to as ‘CETA’, which effectively allows Canadian businesses to export to the currency bloc without tariffs. With Britain leaving, we will have to negotiate a new trade deal or possibly pay tariffs. The UK is Canada’s third largest trading partner, behind the US and China, although it only represents 3% of our total exports.
From a savings and investment standpoint, the majority of the effects will be felt through increased volatility of the financial markets. Markets like certainty and predictability, and despite a rough roadmap, Britain and the EU are now operating in uncharted territory, with each new impactful development likely causing swings in global stocks. Most businesses will likely not be largely affected on a fundamental operating basis, as long as they are not headquartered in the UK, however, movements of capital and fear of uncertainty are likely to increase the movements of their stocks. Gold, bonds, and other perceived areas of safety will likely continue to benefit from this uncertainty moving forwards.
Hard assets and bonds are not the only things that experience rushes of demand, though. The US, as the safest economy in the world, will also likely see increased capital flows into their market. This will likely increase the value of the USD relative to all currencies.
Conclusion
Although undoubtedly momentous, we remain optimistic that any actual tangible negative impact that the Brexit may have will be limited in both longevity and severity; uncertainty is the enemy of the stock market, and will likely pose difficulties in the near term, but it will also likely result in opportunities as well. We are optimistic that the British will be able to negotiate fair deals and that this will not have any sort of catastrophic effect on international markets.
MacNicol & Associates Asset Management Inc.
June 2016
