In a surprising development, the United Kingdom yesterday voted 52% to 48% to exit the European Union (“Brexit”). The implications of this decision are varied. The decision to exit initiates a process of negotiation between the European Union and the United Kingdom. It is important to note that the United Kingdom has yet to invoke Article 50 of the Treaty on European Union. In order for negotiations to begin, Article 50 will have to be invoked, after which there is a 2-year period to negotiate the terms of the United Kingdom’s withdrawal.
In the immediate term, we are seeing a classic flight to quality. Global stock markets are selling off, bond markets are rallying, and the U.S. dollar is rallying relative to European currencies and the pound.
It is unclear what the longer-term effects will be, but it is important to note that we do not view this as a “Lehman-type” event as occurred during the financial crisis in 2008. The financial crisis in 2008 was the result of significant financial excesses and a global liquidity crisis. Brexit is a political event that is expected to unfold in slow motion over an extended period. The world’s central banks are responding by promising significant liquidity and financial markets are functioning normally, albeit with high volatility.
There will certainly be an economic impact to this decision. Longer term, this has the potential to slow global growth, particularly if negotiations between the European Union and the United Kingdom become acrimonious. The potential add-on effects, such as renewed calls for Scottish independence or a “Grexit” (Greek Exit from the EU) would be further distractions.
The impact on the United States may be mixed. We are of the position that the U.S. will be viewed as a safe haven and the result may be strong capital flows into our stock and bond markets. This could result in U.S. bond yields staying lower for a longer period of time, meaning a Fed rate hike may be off the table indefinitely. Lower rates and central bank stimulus could aid the U.S. economy while extended U.S. dollar strength could have a negative impact.
During the second quarter, U.S. stocks have traded in a range—the S&P 500 Index has fluctuated between 2040 and 2120. On June 23, 2016, the S&P 500 closed at the higher end of the range, only 20 points from the market’s all-time high. Today, on June 24, the market has traded lower, but remains comfortably within the same range.
From a portfolio management perspective, we will assess any needed changes as a result of the Brexit vote. Stock market volatility may give us an opportunity to buy stocks we like at more attractive prices. As the impact of Brexit becomes better known, we may need to reposition portfolios differently. We will also assess the impact on broader asset allocation, particularly the appropriate weighting for international equities.
Thomas K. Anderson, CFA
The opinions expressed above are given in good faith, may be subject to change, and are as of the date issued. This communication discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice and does not represent a complete analysis of every material fact with respect to the economy, financial markets, interest rates, and any industry mentioned in the publication. Investment products such as stocks, bonds, and mutual funds may lose value and are not insured or guaranteed by Boston Private Bank & Trust Company or any of its affiliates or by the Federal Deposit Insurance Corporation and any other government agency.