They say that breaking up is hard to do; now I know, I know that it’s true.
– Neil Sedaka
Media and markets are all aTwitter – literally – that a referendum was held last Thursday in which citizens of the United Kingdom voted on whether to remain or leave membership in the common economic cooperative and free trade group / agreement known as the European Union. In the wake of the somewhat unexpected voting outcome – which decided to “Leave” the EU – all varieties of asset markets have sold off globally, and will likely do so for days / weeks to come. US Treasuries are one exception, with the 10-Year Note Yield – which falls as prices rise – falling to 1.46% from 1.74%, down 16% in two days. A less well-known one is an asset class we’ve long advocated; managed futures positions in client portfolios have generally matched equity market downside in the two trading days since the UK vote, but with a positive rather than negative sign.
Ink and electrons galore are being proffered as to expected market and potential investor reaction. (We refuse to even type the B word, which has in our view gone from completely unknown to hackneyed cliché in record time, even in the age of the internet.) We are however getting a smattering of questions from clients, making us suspect more may be harboring uncertainty as well, so we’ll throw our hat in the ring on responses.
With this twist however: we’ll openly admit at the outset that we DO NOT KNOW much more than we do know about the import / impact of this event. We doubt we are alone; the most honest, unscripted comment we’ve heard so far (among a plethora of them), from a money management source who wished to remain anonymous with his decidedly non-house view of the impact: “like I know!” (he was more, ah, colorful, but decorum prohibits a direct quote). In one sense, recent events are of a specific variety of the general category of “the unknowable future” about which in our view 1) prediction is perilous and 2) upon which significant investment action ought NOT to be based.
So spoiler alert: our general response to “what should we do?” type questions about this (or almost any other broad macro event) is largely: NOTHING. Why?
- Most professional investment portfolios have one or more highly skilled, detail-oriented portfolio managers who are well paid to respond at the security level to take advantage of winners and losers related to this and other fundamental events to which asset prices respond. They are far better suited to assess the still-developing impact and take action where appropriate than we or most clients.
- More importantly, the portfolios with which we work have generally developed a long term framework for allocating assets that contemplates even significant near-term uncertain events – a la the Brit vote – while still allowing for a reasonable expectation of achieving investment goals and managing risk.
- In our experience, one of the worst things investors can do to such a well-considered plan is to deviate from it in response to short term price volatility and the emotional response it provokes. Of course part of fiduciary responsibility is to review circumstances in real time and document that review, even if it results in a “no action” decision. We stand prepared for a portfolio-specific phone call with clients to discuss thoughts on managers / strategies that may be impacted by this, both negatively and positively.
With those caveats and provisos, we offer some (hopefully) relevant thoughts below for decision maker consideration and as context for the deluge of media input on the topic in weeks to come.
What do we know?
- Notably, the UK is not a member of the EU common currency the euro, which they declined to enter in its 1997 inception. Of all the EU members, this makes the UK’s decoupling more orderly than for a member that would need to reinstitute its pre-1997 currency. One of the knock-on impacts worrying markets is the “copycat” effect of other countries opting out. Greece was mooted as a potential flight risk long before Britain; the Netherlands is purportedly considering (we hate to even type it) a Duxit. Those that use the euro as currency would have the additional consideration of reviving their former drachmas, guilders, (francs, krona, zlotys… you get the idea) in addition to all the treaty, trade, immigration, legal and tariff issues they are staring in the face across the pond.
- On an ironic note, a frequently expressed worry is that several UK member countries – notably Scotland and Northern Ireland – had referendum tallies indicating a preference for remaining in the EU. This sparks speculation that those areas of the UK may seek independence (a Scottish vote on which two years ago failed to pass) from the UK in order to retain EU ties. Critically, they lack a currency of their own, making it difficult to “secede” prior to EU admission, which is arduous enough. Their experience would be substantively different than the heretofore EU-member but separate currency situation those regions now know.
- In one sense the UK vote is a no more than a specific case of the general “decoupling” of global economic policy indicated by market conditions in late 2015, so presumably some smart folks have been on this for a while. Especially so when you so rarely get a pre-announced event with such a binary outcome where the day of decision is known in advance. There will of course be actual winners and losers, mostly very specific and fundamentally driven by events unknown but perhaps predictable. In that light, there is likely some money to be made; see our #1 above.
What seems likely to us?
- CNBC’s shouting from the rooftops notwithstanding, a deep breath may be in order. The treaty putting the EU together calls for a two year exit process, beginning….well, sometime soon. We still appear to be in the denial phase in some quarters with (apparently quasi-authentic) calls for a re-vote of the issue, leadership changes afoot in both major British political parties, and despite all the sound and fury of the vote, still no formal notification from the UK to the EU about departure in order to start the two-year clock. Got all that? Of course decades of agreements will involve much negotiation of new terms of engagement; wherein both sides (and really all major economic global partners) have much to discuss and much to gain and lose. We expect this to occupy the news for as long as can be expected in our ADD cultural milieu.
- To that last point, we opine that there are probably a (very) few investors who have done analyses on the impact of a major member departing the EU and forming win/lose opinions. In our view, they aren’t likely the same talking heads you will see on television 24/7 for a time here. Most of the TV people are mere speculators; they are playing uncertain odds at best, outright guessing at worst about things that simply aren’t knowable. We also suggest investors keep in mind that it is the height of summer, a traditional ratings doldrums season in la la land, so this “news” is a godsend for cable news. We’re just sayin’.
- Someone, somewhere was badly positioned for this, trading-wise. The outcome was a surprise, though it should not have been (pre-vote polls leaning “Remain” were inside their own margins of error). Portfolio casualties are likely from that, where some trading desk or hedge fund leaned too far out over their skis. Expect to see stories indicating how the June 23 decision “did in” this or that fund or manager.
- There will also be completely unintended consequences, something that loses money or fails in an unexpected way. Given that markets despise uncertainty, financials, especially banks, will trade down significantly, since that is where the casualties will likely emerge. Could this spark a similar crisis to 2008? We’d say unlikely, but we are also on record as saying the post-crisis recovery is both long in the tooth and Fed-juiced. It is no time for heroics, portfolio wise.
- The US Fed is done for the summer (probably all of 2016 really) with their former idea of interest rate increases / “normalization.” Recent events point to a stronger dollar versus the uncertain path for the EU/euro, which will impact earnings in the S&P 500 and we suspect that’s quite enough uncertainty for Fed governors for now. Later in 2016, we’re on record as skeptics that the Fed will make a move during the height of the US election; we’ll stand pat on that.
- The Brits survived for centuries under independent self-rule prior to three decades of kibitzing from greater Europe. We suspect they will both live long and prosper; the average Englishman is surely more upset this morning about the soccer Iceland-exit than parting ways with Brussels.
- The things to keep an eye on going forward are traditional fundamental metrics that of course may well be impacted by last weeks’ events. Some level of additional friction will exist going forward to facilitate the important trade links that will remain between the UK and Europe / the rest of the world. South Korea did the world a favor on the Monday after the vote by indicating its immediate willingness to negotiate updated trade agreements with the Brits. As did President Obama in walking back his “you go to the back of the queue” hardline pre-vote language with conciliatory (perhaps platitudinous) remarks about the “special relationship” between America and its political progenitor.
- On that note, Happy Birthday America! One way or another, “there’s gonna be fireworks!”
- “I object.” “Overruled.” “I strenuously object.” “OVER-RULED!” – A Few Good Men
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This publication is NOT intended, or suitable as a basis for investment decisions. Before taking any significant action, readers should seek professional investment advice that will incorporate their specific investment needs and circumstances.