"Kee" Points with Jim Kee, Ph.D.

The United Kingdom (UK) referendum is over, and a slight majority voted to exit the European Union (EU). A key concern is that this populist sentiment will spread, and that other EU countries, particularly the stronger ones like Germany, will follow the UK’s lead with referendums of their own. That’s possible, but it could also lead to a stronger recognition of their interdependence. It is important to remember that the UK has always had one foot out of the EU door, having never adopted the euro as their currency. Also, this election was about perceived loss of national sovereignty by British citizens. Populist uprisings by definition occur when ordinary citizens feel like they are being controlled by elites, but in the last century most of these have been against capitalism (particularly in Latin America), and the elites have been perceived to be large commercial enterprises. This situation is different; it is an uprising more against bureaucrats and bureaucracy. That’s an interesting aspect of this event that I find missing from the commentary.


At issue was the fact that being in the EU gave the UK (through the “single market”) access to over 440 million customers – almost half of their exports – and a strong inflow of capital or foreign direct investment (FDI) as well as workers. The UK was thought, by the losing “Remain” voters, to benefit from being a gateway to this “single market,” and they feared corporate relocations (i.e. exits) - particularly in financial services - if things changed. In contrast, the “Leave” voters felt that many of these benefits could be negotiated freely without EU membership because most of them are mutually beneficial, and because of the UK’s history of stability (law and order, established legal institutions, etc.). They also wanted stronger controls over immigration, a desire heightened by the European refugee crisis (the Schengen treaty of open borders across 26 EU countries has come under fire following terrorist attacks in Paris and Brussels- Lazard). Finally there was the issue with the EU budget, as Britain contributes more to the EU than it receives.


Nuts and bolts: This outcome is not binding, and by that I mean the UK must now choose to invoke the process to leave, which might not occur. There could even be a second referendum, or revote, down the road. No other country has actually exited the European Union so the process going forward is uncertain. In order to exit, the United Kingdom would have to invoke Article 50 of the Lisbon Treaty (2007), which describes the process of leaving the European Union. However, it is broad and general and lacks specifics. If Article 50 is invoked, then a two-year time frame is set in motion for negotiations and exit unless the EU member countries grant an extension (Lazard, Blackrock). So there are a lot of different potential outcomes for the UK. No doubt uncertainty will negatively influence business and consumer sentiment (particularly in Europe) in the short run. But I also expect that the global policy responses by the world’s key central banks will be strong, with high conviction and little hesitation. That’s important! While we have little experience with this specific type of shock, just as we had no experience with a historical US debt downgrade (2011), near-default (2013), Arab Spring, etc., we do have hard-earned experience at dealing successfully with shocks in general.   

  

Consistent and ordered? The vote to leave was a surprise, but markets had been pricing in some uncertainty around the event. Of course, markets tend to overshoot and undershoot a lot in the short-term, but I find the markets behavior thus far fairly consistent with expectations. Repricing has occurred as new information has been revealed. As for making changes in your investment strategy, remember that it is rarely helpful to sell today what you wish you sold yesterday (Yardeni). That just makes you a victim of volatility. A good rule for investors to keep in mind is that uncertainty leads to volatility, and volatility leads to opportunity. And high quality bonds experienced positive gains as markets sold off, which is why you own them (other safe haven assets, like the dollar, experienced gains as well). All-equity investors should always keep their eye on longer-term horizons and resist the urge to react to current shocks. That’s a proven formula for disappointing long-term results.