Keep Calm and Carry On: Investors are Overreacting to the Brexit Vote
Friday, June 24, 2016
The media is in a frenzy over the surprise Brexit “Leave” vote, and the market reaction has been significant.
The British pound has fallen by roughly 10%; Asian equity markets are off meaningfully, led by a near 8% drop in Japanese stocks; U.K. and German equity futures are down roughly 8% and 10%, respectively; and the futures for the major U.S. equity markets are off a lesser but still significant 3 - 5%.
While major market moves are no doubt unnerving, investors should take a deep breath and relax. Fundamentally, nothing will change right away. The vote to Leave has no legal standing for an exit from the EU. It is merely an advisory. The required two-year legal process to exit the EU will only begin when the Prime Minister of the U.K. invokes Article 50 of the Lisbon Treaty. Not only will trade not collapse in the near term, but the medium and long-term disruption to trade will likely be far less dire than feared, as alternative trade deals will be negotiated if and when the British follow through with plans to leave the EU.
The Brexit vote is a symptom of a troubled world. Social unrest and protectionism are on the rise because there is too much debt in the world and not enough sensible leadership. This is a theme we have been talking about for a long time. Our outlook for sluggish global growth does not change as a consequence of the Leave vote.
Recognizing the world’s challenges and appreciating the slow-growth economic reality, we have purposely advised investors to position portfolios conservatively. While we expect to take our lumps in the immediate aftermath, our portfolios will likely hold up better than the Canadian equity benchmark, given our below-benchmark exposure to cyclicals and high foreign content (which will benefit from weakness in the Canadian dollar).
We expect markets to rally off their worst levels once initial investor panic subsides and more sensible behaviour follows.
Moreover, central banks and governments won’t sit idly by in the face of significant market volatility. If markets don’t stabilize quickly, the authorities will likely step in to calm them.
Time will tell, of course, and we’ll have more to say as developments unfold.