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Brexit: What does it mean?

By David J. Haas CFP®

The news will be filled today with stories about Brexit. As of 9:32AM today, the FTSE 100 index (100 largest stocks on the London Stock Exchange) is down 3.51%, recovering from a much larger drop at the open. The US stock market has just opened, with the S&P 500 down 2.64%.

For those of you who have not been paying attention to our friends in the UK and Europe, Brexit is an acronym for “British Exit”. Exit what? Britain was voting on exiting the European Union or EU. This was a referendum, held yesterday in the UK, on whether Great Britain remains in the EU or starts the process of leaving the EU. Although there were world-wide connotations to this vote, it was actually an internal political matter in Great Britain. Even though the vote was quite close, the British voters have decided to leave the EU.

What’s all the fuss?

The EU is more than just an economic union. From the end of World War II, until yesterday, Europe has been slowly becoming more integrated economically and politically. The EU has its own democratically elected government and has formulated many rules and regulations which the individual national governments within the EU have agreed to abide by. These rules are important in creating a level playing field, so France cannot create different rules for refrigerators and thus not allow German refrigerators to be sold in France. You can actually think of the EU like the United States Federal Government, except for the foreign policy part. So Britain leaving the EU would be like Texas voting to leave the United States. How could that happen? What will the new rules be? Will I need a new license to sell refrigerators in Texas and will those refrigerators now need a special extra-large ice compartment because those are the new Texas rules? And will the rest of the US, not allow Texas residents to live and work in other states? These are similar to the issues facing Britain and the EU right now.

The Markets

The Markets hate uncertainty. When there is uncertainty, there is panic, and markets become volatile and go down. Brexit will affect the currency markets, the commodity markets, and the stock markets. In the short run, the markets might drop sharply, but it is important not to make any rash decisions based on short-term movements. That’s not investing, its speculating. What I expect will happen is that Britain might be very negatively effected in the short and medium terms. The next step in Brexit is that the UK has 2 years to negotiate its exit from the EU. Two years to decide what the new economic rules are in Europe. It would not be surprising if Britain goes into a recession because of this. Europe itself has some problems. Europe has never really recovered from the great recession which started in 2008. Europe might dip into recession again because of Brexit and there are forces in other EU countries which want the EU to break apart. In order to counter these forces, I expect the EU will make changes and that will produce more uncertainty. After all, if Texas leaves the United States, the remaining USA wants to make sure California doesn’t leave too. So we will be really nice to California. That’s what’s going to happen in Europe. There will also be a push within Europe to make it as painful as possible for Britain to leave, just to dissuade other EU members from trying it.

All of my investment clients have a diversified portfolio. The US is fairly well insulated from the turmoil in Europe, but we will be affected as well. The truth is, our economy is doing much better than Europe and is likely to continue to do well. The Federal Reserve Bank is unlikely to tighten during the Brexit turmoil and that means a looser monetary policy over here. So I see some volatility in the US over the near term, but its unlikely the US economy will go into a recession. A diversified portfolio might go down in the short-term, but I think will be up in both the intermediate and long-term. Remember, don’t make panic decisions. Sharp downturns are sometimes followed by sharp upturns. You’ve probably already caught the downturn and you need to be in the market to catch the upturn.

Why did the UK vote to Leave?

I think the vote had a lot to do with anti-globalization and anti-immigration. These same political currents are moving in the rest of Europe and in the US. Globalization has not been kind to average people. The people getting richer are the owners and stockholders of corporations and their CEOs and top managers. The average worker has not gotten any raises in a long time and is lucky to even have a job. Manufacturing has been moving to low-wage countries and meanwhile, economic turmoil and wars has caused a great migration in the world of refugees from poor countries to rich ones. Politicians are telling the people that they can turn-back the clock and change these currents. My personal opinion is that its very unclear globalization will change. Technology has brought about globalization and governments will not be able to change it. Immigration is probably necessary to developed countries because without it our birthrates are too low for economic growth. Japan is a great example. They don’t allow much immigration and they have a low birthrate. They’ve been in a 20+ year period of recession and slow growth because of it. I’m the son of immigrants and I always felt that immigration has made the US strong, not weak. So Britain is likely to turn into Japan if they’re not careful.

Best Move

I highly recommend making travel plans to the UK. It might be a great opportunity for a bargain right now. The Pound will be down sharply and US consumers have never had so much buying power in Britain and Europe right now. Just don’t talk politics when you get there!

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