D’Arcy Capital Summary of the United Kingdom’s Vote to Leave the European Union (aka Brexit) and the Subsequent Resignation of Prime Minister Cameron
- D’Arcy Capital expects U.S. stock markets to open 400 to 600 points lower on the Dow Jones Industrial Average (the Dow) as a result of Brexit on Friday, June 24th
- The selloff will initially take U.S. stock markets back to levels that existed as recently as four weeks ago (about 17,400 on the Dow). The media reports will make the decline seem worse than that.
- European stock markets will decline by 6% to 10%. Effectively erasing the year-to-date gains in European indices.
- The U.S. stock markets will probably recover more quickly than European markets as certainty around the UK exit process emerges. Dow futures dropped over 750 points when the result of the vote was originally announced but have steadily worked higher in early morning trading (currently down 485).
- The selloff will seem greater than it is because the Dow gained 230 points on Thursday as voter surveys pointed to a stay-in-the-union victory
- Investors should hold or increase U.S. stock investments during any selloff in equity markets. D’Arcy Capital is prepared to deploy cash in response to any stock market decline.
- The currency markets will take longer to adjust. The British Pound will fall against other major currencies until it is clear that Britain can thrive economically outside the European Union. UK tourism and UK products purchased by citizens of the United States will get cheaper.
- The decision by the British to leave the European Union was a sovereignty issue and not an economic one.
Further Detail and D’Arcy Capital’s Approach:
What Has Happened – The citizens of the United Kingdom have voted to leave the European Union. This came a day after surveys indicated the result would be to remain in the EU. British Prime Minister David Cameron has announced he will resign by October
What Will Happen Next – Britain will enact Article 50 of the Treaty on European Union to begin the process to leave the European Union. Prime Minister Cameron indicated this would happen once a new Prime Minister has been chosen. It will take a minimum of two years for Britain to leave the EU after Article 50 has been enacted. This will be a protracted process that seeks to maintain the economic benefits for both Britain and its trading partners.
What Does This Mean for Financial Markets and Investments – In the short-term financial markets will experience high volatility as investors work to determine the actual impact of the UK leaving the EU on global stock prices. England will be the epicenter of the volatility and declining investment values. The UK currency (British Pound) will decline close to 10% versus other currencies. Stock prices of United Kingdom based companies will fall as Britain loses trade partners and faces higher labor costs. More broadly European based companies will also decline as the world’s 5th largest economy exits the European Union. The impact on U.S. and China based stock prices will be an initial selloff with a prompt return to current price levels.
In the intermediate-term stock markets will gain and bond prices will sink as investors realize the process for the UK to leave the EU will be gradual and will take time. As more clarity on the leaving process materializes, the value of global equities will return to pre-vote levels. Investors love certainty and hate uncertainty. Everything will continue to get more certain from this day forward. Additionally, as it becomes evident that the UK is financially strong enough to handle an economic downturn, stocks will recover.
In the long-term it is in the best interest of all European Countries to reconstruct trade, banking, and employment agreements with the United Kingdom. This redevelopment of open trade channels will restore higher stock prices across Europe.
What Are the Risks – The risk is that the United Kingdom will have difficulty finding receptive markets in other European countries and EU countries seek to punish the United Kingdom for leaving the European Union. The ultimate risk is that many other countries choose the same path as the UK and exit the EU to the point that the EU ceases to exist.
What is D’Arcy Capital Doing as a Result of Brexit – For the individual diversified portfolios D’Arcy Capital built a 5% cash position on May 10th when the Real Estate Investment Trust position was liquidated. If a decline in U.S. security prices materializes, D’Arcy Capital will use the volatility to invest this cash. Beyond using the volatility to deploy cash, it is important to not to make a long-term mistake to a short-term issue. Although Brexit is a major political event, it is much less of an economic event for U.S. based investors. The U.S. economy will continue to create jobs, maintain low unemployment levels, generate corporate profits, and maintain low interest rates. The Brexit may create some benefit to U.S. stock markets as it reduces the likelihood that the Federal Reserve will raise rates significantly in 2016. D’Arcy Capital believes the UK will follow an orderly exit from the EU. D’Arcy Capital will continue to monitor the developments in Europe and make changes accordingly. D’Arcy Capital does not anticipate any adjustments to the bond portfolios or the large cap value portfolios.
Closing Points –
- The Brexit will not fall outside the acceptable events that occur during normal investment cycles
- D’Arcy Capital believes long-term equity returns will not be effected by Brexit
- The impact on stock prices will appear more severe since the Dow Jones Industrial average gained 230 points on the day just prior to the leave or stay vote in the U.K.
- Investors should use any selloff in U.S. stock markets as an opportunity to deploy cash balances.
Investors should not overestimate the actual impact Brexit has on global stock and bond markets.