Keep Calm and Carry On

by Shawn Narancich, CFA Executive Vice President of Research

Careful What You Vote For

Great Britain threw financial markets a curve ball last night in voting to exit the European Union, with 52 percent of voters electing to leave the 28-nation economic block. In the days leading up to last night’s vote, equities and commodities strengthened in anticipation of just the opposite vote, so the reaction in asset prices today is predictable – stocks in major European markets closed down by 3-9 percent, the British pound touched 30-yr lows, oil is down 5 percent, and U.S. stocks are off 4 percent. On the flip side of the coin, the trade-weighted U.S. dollar is up 2 percent and U.S. Treasuries are surging, with yields touching three-and-a-half year lows. With the sell-off today, the S&P 500 is now in negative territory year-to-date.

One Vote Down, More to Come?

The downside in risk-facing assets today reflects the fact that the world’s fifth largest economy has elected to sever its ties with Brussels, abrogating its immigration and trade policies with key European trading partners. Even more so, investors are concerned that Great Britain’s vote may presage additional European turmoil. British Prime Minister David Cameron is resigning, leaving financial markets to presume a more insular UK economy and, with the UK itself, the possibility of a break-up if the “Bremain” voting Scottish voters push for another secession vote. More broadly, we observe a rising tide of political populism that could result in additional EU membership votes by countries such as Italy, France and the Netherlands. While it’s not our prediction that “Brexit” will lead to a break-up of the broader European Union, investors will have to contend with this tail risk.

Managing Uncertainty

For now, equity valuations are adjusting to what we believe will be the result – reduced levels of business confidence and investment amid required new European trade agreements and immigration policies, as well as a stronger U.S. dollar that challenges U.S. exports and multi-national profits. While weaker investment at the margin will serve as a blow to global growth, we foresee continued economic expansion.

Easy Money

Central banks globally, including the Fed, stand ready to offer added liquidity for money markets to help insure against near-term dislocations, while also continuing to promote low interest rates as ongoing economic stimulus. Domestically, key mitigating factors for the world’s largest economy include a strong job market and even lower interest rates, which should continue to support housing and the largest component of GDP … consumer spending.

Cooler Heads Will Prevail

We note with a keen sense of irony a mantra first penned in World War II by none other than Great Britain: “Keep Calm and Carry On.” On behalf of our clients, we are not recommending any changes in asset allocation at present. While this could change with additional developments, we believe clients are best served to stay put amid this knee-jerk reaction globally.

Our Takeaways from the Week

  • Stocks succumbed globally to Great Britain’s vote to exit the EU
  • While a headwind to growth, “Brexit” should not precipitate recession