As newspaper headlines show this morning, the British people voted yesterday to leave the European Union. While the tally was always expected to be close, as late as Wednesday, both polls and odds makers were giving a significant edge to “Stay.”
As with any unexpected political or economic event, markets experience knee jerk reactions. With this in mind, we wanted to give you some context around what this means for markets and more importantly what it means for truly diversified investors.
The CIA Investment Committee believes most of what we are seeing in the markets today and in the coming days/weeks should be largely construed as noise and not an indicator of lasting trouble to come. We do not see a serious impact on the U.S. economy; however, events such as this remind us of the importance of maintaining diversification.
Looking to history for more context, the majority of “crisis events” have led to significant buying opportunities. From 1907 until today there have been 51 events which led to large market sell-offs. Examples include the Panic of 1907, WWI, Pearl Harbor, the Cuban Missile Crisis, the Arab Oil Embargo, Financial Panic of 1987, the Asian stock market crisis in 1997, 9-11, and Lehman Brothers in 2008. It’s a long list.
The average down draft from the initial reaction is -6.7%. However, 22 days post-market sell-off, markets were up 3.7% on average. Then 63 days later up an average of 5.2%, and 126 days, 8.9% higher.
So in most cases, time quickly heals these wounds. The market digests change and looks to the future.
The vote no doubt has consequences for Great Britain. Its currency, the pound, has already dropped to its lowest level against the dollar since 1985. The country’s departure from the E.U. will take two years, during which there will tremendous uncertainty about what’s to come. Post-exit, it will be more difficult for British companies to trade with the continent and the U.K. may have less influence on the global trade policy stage.
But the impact on the U.S. economy, short-term and long-term, should be minimal. We like to judge the structural health of the economy by a bundle of measures we call CHIME. For the most part, these indicators remain positive:
- Consumer Spending – Trending up 4% during Q2.
- Housing – Existing home sales are at their highest level in more than nine years.
- Interest Rates – Money remains cheap and the Federal Reserve, already hesitant to raise rates, will likely put any hikes on hold in the wake of the Brexit upheaval.
- Manufacturing – This trend has turned towards expansion and is well above where we began 2016.
- Employment – Despite a shaky most recent jobs report, jobless claims remain low and unemployment is at a tolerable 4.7%.
Make no mistake, the Brexit vote and resulting uncertainty will send U.S. markets spinning for several days or weeks. The flight to safe assets has already begun, including nearly all high quality bond categories.
The Brexit vote does not herald the end of the world or the global economy. However, Britain and the European Union now face some serious questions and issues. For U.S. investors, though, don’t let the doom and gloom headlines you’ll see in the coming days scare you. Remember, newspapers are in the business to sell newspapers.