The short answer is, volatility will increase. But it doesn’t take the deductive powers of Sherlock or Mycroft Holmes to figure that one out. It’s cold comfort to investors who have lost money to know that most other investors did as well. And comments about this taking us back to the days of the Maastricht Treaty of 1992 aren’t helpful. This isn’t 1992, and Brexit isn’t taking us back there.
But the “lookback” commentary has a point. Brexit represents a break in 70 years of European integration. Since World War II, European nations have been moving closer, driven by a commitment to never experience such a huge global cataclysm again. The UK has always been ambivalent about this project, in part because for them, World War II is a point of pride. It was “their finest hour,” and popular culture still make reference to a greatest generation that won the war.
The EU Treaties. Source: Wikipedia
Brexit is part of a deglobalization trend that has been growing since the Financial Crisis. In hindsight, the Crisis will be seen as the last time the global community came together to solve a common problem. Central banks and national leaders coordinated monetary and fiscal stimulus and support for systemically important institutions. There was great resentment, however, that a real-estate boom and bust in the US should lead to a global economic downturn.
In April 2009 Bill Gross—then at PIMCO—suggested that looking forward, deglobalization would become increasingly important. He expected that the future would be characterized by more trade barriers, financial mercantilism, and government support for local companies. He could add to this list “nationalist populism”: a desire by everyday citizens to take their countries back from a supranational, cosmopolitan elite—the folks who gave us the Financial Crisis, then profited from the subsequent bailouts.
The UK’s referendum is part of this deglobalizing trend. Concern about immigration and an economy that leaves a good part of its population behind has crystalized behind a desire to use local money used for local purposes. For example, the “Leave” campaign argued that their EU dues could be re-directed to support Britain’s National Health Service.
Brexit doesn’t enact any law. That will require an act of Parliament. The 1972 European Communities Act hitherto ensured that the UK would automatically incorporate EU directives into law, establishing the priority of EU law where it contradicts British law. This was a key part of the sovereignty argument behind Brexit. This law will have to be replaced.
Brexit will not stop Britain from trading with the rest of Europe or the world. But it represents a break with the past, and it raises the specter of more referendums in other countries—notably France, which is truly at the heart of Europe. In 1992 France narrowly supported the Maastrict Treat with just 51% of its people in favor. Opponents included the French Communist Party and the far-right National Front—similar to the left-right opponents to global trade in the US. In 2005, France and Holland both voted overwhelmingly against adopting the EU Constitution.
So get ready for some significant swings in stock and bond markets around the world. There will be risk-off days when bonds and gold rise, and risk-on days when stocks and high-yield debt rally. Volatility will increase, although not to the levels of 2008 and 2009. Bonds issued by peripheral European countries will sell off, as they are not borrowing in their own currency—they can’t just print money to pay them off. The ECB has said they will do “whatever it takes” to hold the Eurozone together. We’ll soon see if they have what it takes.
At times like this, it makes sense to take some time and resist making any rushed investment decisions. The current market sell-off may represent a buying opportunity in equities, especially in the short term. We want to be greedy when others are fearful, and there’s a lot of fear in the market right now. Longer term, however, the future is murky. Brexit has the potential to change the world. Right now, though, it’s unclear precisely how.
Douglas R. Tengdin, CFA
Chief Investment Officer