By Jon Gardey, President and CEO
The recent Brexit vote and stock market reaction has dominated the news lately. On June 23, the citizens of the United Kingdom (England, Scotland, Wales, and Northern Ireland [otherwise known as the UK]) voted to leave the European Union (EU). The EU, based in Brussels, is a political and economic union of 28 European countries. The EU got its start in the 1950s as the European Economic Community and was formally established by the Maastricht Treaty in 1993. The EU constitutes 20% of the world’s economic activity and 508 million people who own 30% of the world’s estimated wealth.
Membership in the EU has been considered permanent and there was never any thought of a country leaving the union. Most discussions about why they chose to leave the EU seem to boil down to immigration, national identity, and local control. We don’t believe that the UK was ever as fully committed to the EU as have been France and Germany-the main drivers behind the EU. This is based on the UK’s long history of detached involvement in European affairs and the fact that they didn’t adopt the euro as have 19 other countries.
The more important question for investors is this: What will be the long-term consequences of their exit? It is unclear to everyone at this point what this will mean. Speculation has included falling investor confidence, market turbulence, a plummeting pound, reduced British gross domestic product (GDP), and increased unemployment. Will these worries come to fruition? The problem is that no one knows. Some “experts” like the International Monetary Fund (IMF), the UK Treasury, and the Organization for Economic Cooperation and Development (OECD) have warned of dire consequences.
The process for the UK to separate from the EU starts with Article 50 of the Lisbon Treaty made up of five short paragraphs. The article states that a member state can withdraw from the union by notifying the European Council of its intentions. This starts a two-year window for the departing state to negotiate the terms of its departure with the EU. If the negotiations are not completed by the two-year deadline, all current treaties will then cease to apply unless the time period is extended. At this point, Article 50 has not yet been triggered.
The campaign to stay or withdraw was bitter, and the result has caused significant political turmoil in the United Kingdom. The current prime minister, who campaigned to remain, has resigned but will remain as prime minister until at least October. The leader of the opposing party, who also campaigned to remain in the EU, is in the process of being removed from his post by his own party. Thus, there is no effective long-term leadership in place to guide the process from the UK’s side at this time.
It is clear that this will be a long and drawn-out affair. Markets do not like uncertainty and this process is fraught with lots of uncertainty. Initially, stock markets around the world declined dramatically based on the news. The world has become so much more economically integrated that problems in one area have direct impacts on the rest of the world. As of the writing of this e-newsletter on June 30, 2016, markets have recovered some of those initial losses.
The bigger worry for the market is that other countries will decide to leave the EU, and if enough countries do this, the EU would effectively cease to exist.
As the exit process proceeds, we believe that there will be bouts of market declines and bouts of market euphoria. We won’t know for years if this was a good decision or a bad decision for the UK. We expect more volatility in the future and over time as the markets come to understand the consequences. The best course of action is to monitor the situation closely and maintain a broadly diversified portfolio of investments. Depending on the outcome of the Article 50 negotiations, we think that this can be a win-win for the UK and the EU. We believe that ultimately they will figure it out and the world will move on.