On June 23rd, the citizens of the United Kingdom voted to exit from the European Union (EU) with a 52% to 48% in favor vote. Breaking down the vote, Scotland, Northern Ireland and London proper voted overwhelmingly in favor of staying in the EU, while rural areas of the United Kingdom voted to leave the EU. This vote was essentially about immigration and trade. Similar to other nations, the rural areas have experienced more disruption by globalization as the world economy continues to be sluggish resulting in economic hardship for those further away from the cities. This has led to an increase in nationalistic and protectionist movement.
Although it is no surprise that the markets reacted negatively to the news, they were very orderly with no major disruptions in trading and liquidity. There was shock and disappointment by the financial markets, leading to an emotional response and a potential overreaction in the equity markets. A flight to quality was spurred, moving the dollar higher versus other currencies and sending U.S. treasury yields to lows not seen since 2012. As the news settled in, these markets rebounded slightly but still left investors with a sense of concern.
What does this mean for the future of the global economy and investing? Following are key points regarding the long-term impact on portfolios.
- Two years for implementation – The effects of today’s vote will not be felt immediately. The United Kingdom’s exit from the E.U. will be a gradual process. Once the UK has triggered Article 50 (the article that states the wish to exit the EU), there is a two year time frame for full implementation. The process of negotiating with the EU may be challenging as the EU does not want other member countries to think it is easy to break away from the Union. This is likely to cause more volatility in the market.
- Slower growth – The United Kingdom’s rate of economic growth may slow, potentially leading to a recession. The British pound has weakened and may continue to weaken leading to several positive outcomes including cheaper exports and lower interest rates. European economic growth may be negatively impacted but the U.S. economy should not. The United Kingdom is only 4% of the World’s GDP and because full implementation will span two years, it provides time for transition and adjustment.
- Low interest rates – Interest rates will continue to be suppressed. The Bank of England has pledged to provide liquidity and will potentially lower rates. A rate cut is being priced into the market as of this morning. The disruption in the markets and the potential impact of this change likely allows the Federal Reserve to maintain rates at current levels for a longer period of time and move future rate hikes to later this year or early next year.
- Volatility = long-term opportunity – Market volatility provides opportunities to long-term investors. We expect increased volatility in currency and equity markets due to this recent decision but believe that the U.S. economy will continue on its slow growth trajectory, providing growth for long-term investors.
This action creates risks to the political and economic landscape. Despite the increased volatility, we believe the rewards outweigh the risks for long-term market investors. We will be closely monitoring this situation. If needed, we will make appropriate adjustments to our portfolio. As it stands today, we do not believe changes are warranted as a result of this vote.
Elizabeth S. Pierson, CFA, is SVP, Chief Investment Officer at Alpine Trust & Investment Group. She’s a Chartered Financial Analyst and has more than 31 years of experience.