Darrell Bryant Retirement Blog

Tuesday, June 28, 2016

Important Market Update // Brexit Analysis

By Darrell Bryant

The Brexit votes have been counted, the UK has decided to leave the European Union (EU), and David Cameron has stepped down as Prime Minister. According to reports the votes were geographically segregated as England and Wales were generally pro-leaving while Scotland and Ireland were generally pro-staying in the EU. The votes were also segregated across age and education demographics, with a clear trend of younger/more educated voters landing on the pro-staying side and older/less educated voters landing on the pro-leaving side.

 

It is clear the Brexit decision has had an immediate negative impact for the global equity markets, so why did a majority of voters (51.9%) want to leave the EU in the first place?

 

  • Estimates showed that the gross cost of EU membership was about £350M/wk (but the net total economic cost is closer to £136M/wk after up-front rebates and the EU spending money on the UK). Pro-leave voters argued this money could be spent better elsewhere, such as new British industries and scientific research.
  • The Common Agricultural Policy, a system of subsidies introduced in 1962 to support European farmers, is criticized as being too costly and wasteful. By leaving the EU, the UK can pursue more international trade deals with countries such as China and India rather than paying for the inefficient production of goods.
  • One of the EU’s strongest principles is the free movement of people, goods, services, and money across borders. While part the EU, the UK would have no control over immigration from other EU member states. This was creating an issue on how to regulate welfare as immigration to the UK was becoming more prominent.
  • Leaving the EU will allow the UK government more freedom to control healthcare, law, and international trade agreements.

 

These seem like sensible reasons for the UK to separate from the EU, but there are two sides to every story. There may be some foreseen, but unintended, consequences for the UK as well as the global economy in the coming months and years.

 

  • The EU is the UK’s largest trading partner, accounting for about half of all UK imports and exports. Though the UK can enter into trade agreements with EU countries the terms will likely not be as friendly as they are at the current time, resulting in lower trading activity and increased trading costs between the UK and EU.
  • Scotland is expected to hold a referendum to leave the UK. In the most recent 2014 poll, Scotland decided to remain part of the UK arguing that the UK safeguarded their future in the EU. With the recent events, many expect another poll in which Scotland could separate from the UK in order to join back with the EU.
  • The decision for the UK to leave the EU can be interpreted as a form of deglobalization and a step-down from free trade, which is a negative for both the UK and the global economy. Deglobalization will likely lead to lower GDP in the UK and could trickle over to surrounding countries as the current balance of imports and exports is interrupted. The UK is expected to go into a recession, but this could happen at a more global level as well.
  • Foreign investment into the UK is likely to slowdown as investors will be scared away due to the large levels of risk and uncertainty surrounding the Brexit decision.
  • There will be political uncertainty as the UK develops an exit plan from the EU. With the resignation of David Cameron and a new regime stepping in, there is not much clarity for the exit plan.
  • The door is now open for other countries to attempt to leave the EU. Until now, no country had ever severed their ties with the EU. There is fear that other countries could follow suit in the coming years, resulting in a breakup of the EU all together.

 

Only one thing is certain at the moment: there are still many uncertainties surrounding the Brexit decision and nobody knows exactly how this will all play out. Emotions and panic can cause investors to make poor decisions in times like these, which is why it is imperative to stay committed to a smart investment strategy over the long-run. By avoiding the urge to make a knee-jerk reaction to daily news, long-term success is more likely to be achieved.