An unexpected vote by the United Kingdom to leave the European Union has resulted in global financial market volatility. Understandably, investors will be concerned and wondering how to react to this news. Simon Hudson-Peacock, consultant to Southwood Financial Planning, discusses the implications of the referendum on financial markets and suggests that there may be some upside from current levels. Don’t panic!
The movement in financial markets last week following the UK’s decision to exit the EU remind us all that market expectations can be very different from reality. In this case, financial markets failed to appreciate that the voters in last week’s referendum did not share the same rational conclusions that the “experts” had arrived at after weeks of analysis leading up to the actual vote. The economists, hedge fund managers and strategic think-tanks concluded that the economic impact of Brexit was too dire for any rational person to vote for. Therefore, there was little chance of a “leave” vote.
However, it was not the experts who won on the day. It was the older population and younger, working class people in Britain that voted for Brexit. These were voters who didn’t care or possibly didn’t understand the economic consequences of departure because they were already poor or, paradoxically, already financially comfortable. They were instead overwhelmed by the fear arguments of uncontrolled migration of Muslim refugees and Eastern European work seekers through the EU that threatened their jobs and overall national security.
The economic consequences of the UK’s departure are certainly negative. Europe is weaker for the UK’s departure because the UK was an important stabilizing economic contributor to the single market. Now, the UK must trade with its European neighbours at arms length with more onerous bureaucratic hurdles in place e.g. permits, duties and visas. Financial institutions are already looking to move their headquarters out of London.
Society has also been impacted. The UK has been divided across most of its traditionally uniting mechanisms; political parties, geography and family. The Prime Minister has resigned, the opposition Labour party is disintegrating, Scotland wants to vote on devolvement from the UK once again. Sadly, there is no respected heir apparent to lead the UK out of this crisis.
Markets are medium term efficient. Put another way, it takes a while before the market correctly interprets new information. Asset prices moved the way they did last week for two reasons. Firstly there was new information; the UK had unexpectedly voted to leave the EU. Secondly there was uncertainty; what was the longer-term impact of this?
Volatility in share prices and currencies comes reliably from such an unhappy combination. The financial experts will be busy calculating the consequences of Brexit whilst analysts and portfolio managers will be demanding higher risk premium in asset pricing. Consequently, company earnings forecasts will fall and valuations further compounded by more punitive discount rates.
That said, now is not a good time to be making big decisions on ones’ portfolio. Market timing is difficult if not impossible. An unexpected event has occurred and asset prices have adjusted accordingly. We must now wait for the unwinding of the uncertainty factor. More bad news may follow but correspondingly more certainty should come with it.
Of course it is also possible that things won’t be as bad as the current headlines suggest. The UK will become more autonomous and better able to make decisions that suit it. It will surely enter into new trade and security agreements with the EU, albeit at less friendly terms. As certainty returns and the new paradigm asserts itself, life (and asset prices) will also return to the new normal.
If anything, investors should take this experience as a reminder about the benefits of diversification. No one can predict the future and even safe, well-developed economies can experience shocks to the system. Don’t overly concentrate your portfolio; it’s often a sign of overconfidence. And, as we have just seen, there were a lot of extraordinarily clever people who got things very wrong last week!