As one very well-respected British commentator (Martin Wolf) remarked over the weekend, “The hinge between the EU and the English-speaking powers has been snapped. This [Brexit] is probably the most disastrous single event in British history since the second world war.”
Brexit is very sad news but from a global economic standpoint there are no signs that the vote will precipitate another 2008. I can’t stress that enough. Commercial banks are far more capitalized and less leveraged than they were in 2008, and the big ones have all been subject to stress tests to make sure they can better withstand various outbreaks of trouble. Indeed, early indications show that trading has been orderly with few liquidity problems. Finally, and very importantly, central banks have learned how and when to react quickly and how to do so in a more coordinated fashion. Britain’s central bank governor has already come out promising to do whatever it takes to stabilize markets and the heads of all major central banks are meeting literally as I write.
I don’t even think Brexit is going to cause a recession in the U.S. American exports to Britain last year totaled $56 billion, or just over 0.3 percentage points of GDP. A slowdown in Britain’s economy, while not great for growth, is hardly going to be enough to throw the U.S. economy into a tailspin. Recent economic indicators are actually pretty decent showing continued recovery in the U.S. manufacturing sector and robust consumer spending.
We will feel some impact but it will mostly be felt through the falling value of the pound and the euro against the dollar, which is likely to slow down inflation. A stronger dollar will also hurt U.S. exporters whose goods will become more expensive for U.K. and European consumers. We are obviously also feeling the general decline of the stock market as risk gets re-priced globally.
The same cannot be said for the U.K. A recession is a distinct possibility but the outcome may well be delayed as British exporters enjoy their increased competitiveness due to the sharp drop in the value of the pound. The real problem is that exit negotiations are likely to take a long time ushering in a period of uncertainty and declining investment in the U.K. After all, who wants to build a new plant in the U.K. without knowing what market access they will have?
Earlier this month, we reduced exposure to both Europe and Japan between 10-20% in the majority of our client portfolios in favor of real estate. We did so less as a hedge against a Brexit vote (I, like many, was shocked by the outcome), but rather because growth and company profits in Europe and Japan continue to disappoint. We also remain maximum underweight emerging market exposure, a good place to be given that a stronger dollar will likely put renewed pressure on emerging markets equities and debt.
We are not planning to make any further moves at this time. As I have written before, trading in a storm is a recipe for selling low and buying high. Markets tend to overreact at first as traders are forced to unwind their losing bets. I also believe that Brexit will not deliver Lehman-like troubles.
Notwithstanding all of the above, we are in a new period of potentially prolonged uncertainty and we know that markets do not perform well under such circumstances. Nobody yet knows what the ultimate economic fallout will be and so we will continue to monitor the situation very closely and will reevaluate our position if necessary.