Add “Brexit” to the Long List of Uncertainty

A few weeks ago there was polling going on in Britain showing that the push to leave the European Union was statistically ahead of those who wanted to stay in the European Union.  It had an ominous effect on the markets as the Dow fell about 400 points in five days.  European stock markets were sharply lower as the German DAX fell from more than 10,200 to about 9,500 in that same period of time.

By yesterday, the day of the British vote to leave the EU, the Dow and DAX had staged a sharp weeklong rally.  This rally coincided with polling samples that showed that the vote to stay in the EU had regained the lead.  Markets were confident that they could rally in the face of the election that they thought would maintain the status-quo (certainty).

Of course, we know the surprising results now and realize that the recent polls were wrong.  The British have now voted to leave the EU, an unprecedented occurrence that has potential ramifications many are trying to absorb.  Because of this, it looks like this morning we are giving back a week of gains plus a little more as uncertainty prevails and panic selling has ensued.

So what could be the ramifications of this vote?  The first thing that will happen (besides David Cameron’s resignation) is the British will begin to negotiate the legal process of their way out of the EU.  There is no road map, by design.  This was not supposed to happen.  The British referendum is not “legally binding”, but with Cameron’s resignation it looks as if they will proceed with the will of the people.  This is what adds to the continued uncertainty.

What will they be negotiating?  First, Britain it is not getting out of the euro currency.  The British never adopted the euro currency to begin with so they don’t have to “convert” back to the pound sterling.  What they are doing is getting out of the economic and political union of 28 countries that was established after World War II to promote unity between Germany and France that laid the foundation for further entries by European countries.  Economically, they agree to trade under the same agreements, politically they have agreed to common borders and abolished passport controls (although the British were never in that particular one).  This agreement has been great economically for London as they became the financial hub of the EU over the years, a position that is now threatened.  You’ll notice most Londoners voted overwhelmingly to stay.

Essentially, the biggest thing this vote does is allows for Britain to negotiate its own agreements of trade with the rest of the world, including the rest of the EU.  This is why it is so risky and there are worries it will damage their economy.  Will the EU play hardball to make an example out of them in negotiations?  How will other countries such as China treat them?  These economic agreements range from financial services legislation to fishing quotas.

This is why the markets are reacting the way they are today.  Uncertainty is back and the market is repricing in that risk again as it did two weeks ago.  Unfortunately there is going to be plenty of time for “experts”, who probably got the election call wrong in the first place, to weigh in on what they think will happen next.  The talking heads will give you a litany of reasons why they know what will happen next, when in reality they are just guessing.  The trick is not to react to that.  You’ve already laid out your plan and investments to account for some short-term volatility.  This is why we have our clients invest in the boring, high grade, low-yielding fixed-income instruments.  It is not because of the great returns, it is to be the portfolio ballast in times of rough seas.  It’s to allow you to not have sell equities on a day the market drops wildly.

For example, I am sure companies like Union Pacific will be down today, perhaps materially.  But ask yourself when you see it, why a US railroad would be impacted by the British voting to renegotiate their trade compacts with the rest of the world?  I am sure some of those railcars are moving crops or something to the coasts to send to London so there will be some impact, but probably not to the extent of the decline of the stock.  The point is that it is the uncertainty, not the result of the election that is moving the market and UP stock.

We’ve battled with a lot of uncertainty lately, and always will.  For if it is not “Brexit”, it is things like rapidly falling oil prices, oil spills, Greek worry, US debt downgrades, taper tantrums, Ebola, China worries or subprime mortgages.  This is just the newest uncertainty and there will be another in the future we can’t even predict.

It’s not fun, but we have to live with this unpredictability to generate return in the stock market.   It’s also part the reason we have pay the price occasionally with volatility.  This is why we plan the allocations so carefully, taking enough risk that we can earn the returns but not too much that we have to pay a price you aren’t willing to pay to sell and realize the losses at an inopportune time.

Important Disclosure Information

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Lutz Financial), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Lutz Financial.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  Lutz Financial is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of Lutz Financial’s current written disclosure statement discussing our advisory services and fees is available upon request.