Stocks fell sharply last week in response to Britain’s vote to leave the European Union (EU), putting major indices in the red for 2016. Why did markets react so badly?
The vote to leave was a surprise to most, and markets hate surprises. It’s too soon to know how Britain’s exit (Brexit) will play out, but predictions include a British recession, a breakup of the EU as other countries vote to leave, or the introduction of reforms by European leaders who see the writing on the wall. Since the referendum result isn’t binding on the government, there’s even a very small possibility that the Brexit won’t happen at all.1 It’s anyone’s guess at this point.
To help you understand how the Brexit may affect you as an investor, here are answers to some key questions:
How will Britain’s vote affect markets?
In the short and medium term, we’re likely to see a lot of volatility in financial markets around the world as investors grapple with the uncertainty of possible Brexit outcomes. In the long term, it’s hard to know what the final tally of the Brexit will be.
If we look at similar events such as the Fiscal Cliff standoff in 2011 and the European debt crisis in 2012, we see that though stocks fell significantly in the days and weeks that followed, prices later rebounded as the uncertainty cleared.2
Is that what will happen this time? Possibly, but we can’t predict the future. While political events like this rarely have a long-term effect on markets, we should also keep in mind that 2016 has brought many geopolitical challenges to our door.
How will Britain’s vote affect the U.S. economy?
Currently, there’s no consensus from economists on what the fallout in the U.S. will be. Trade with Britain accounts for just 0.31% of U.S. Gross Domestic Product (GDP), so British problems with trade won’t necessarily affect us.3 However, the dollar is often viewed as a safe haven in times of international turmoil, which is pushing the dollar’s value up versus other currencies. A stronger dollar may weaken demand for U.S. exports, which isn’t good for our economy.4
Globally, Britain accounts for 4.82, of worldwide GDP.5 We don’t yet know how negotiations over trade, labor, and finances will affect Britain’s economy. If Britain’s exit kicks off a mass exodus of EU member countries, we can certainly expect a greater impact on the global economy. However, it’s too soon to know if that will come to pass.
Britain’s vote will likely affect Federal Reserve policies this year. Post-Brexit, expectations of a rate increase this year have gone down tremendously. Some experts even suggest that rate cuts may be back on the table if economic growth slows.6
Though we don’t think the Brexit is the end of the world, we want to acknowledge the risks it poses to markets. We believe that bull markets don’t die of old age, but we are facing growing headwinds from abroad that may threaten the bulls.
Unfortunately, we can’t predict the future. What we can do is focus on long-term financial goals and look for opportunities in the turmoil. The emotional reactions of others may create rational opportunities for us.
We are continually monitoring client portfolios and evaluating economic data and market research as it arrives. We will keep you informed and will contact you personally if we feel changes to your portfolio are necessary.
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