We want to share our initial take on the Brexit, yesterday’s referendum in which Great Britain voted to leave the European Union.
The results are roiling markets around the globe, and we see three reasons for the significantly negative investor reaction: First, there is concern about an economic drag resulting from greater challenges around trade and commerce involving Britain, the world’s fifth-largest economy. Second, there is fear that Brexit reflects a concerning rise of nationalism and the possibility that Britain’s vote is only the first step in an eventual unraveling of the European Union; a development which would have significantly negative economic consequences by adding major headwinds to European and global trade. Third, there is great uncertainty surrounding the Brexit decision; no one knows for sure how this will play out and what the effects will be. Markets don’t like uncertainty.
Clearly, riskier assets, especially equities, are most impacted and they are selling off sharply. We’ve also seen the customary flight to safety typical at times like this, with U.S. Treasurys and gold rising sharply. While we are still assessing the short-term and long-term impacts, we have been considering the investment implications of a Brexit for some time, knowing that polls showed the vote would be close and a Brexit was a real possibility. However, our investment process does not involve making bets on macro events that are often priced in very quickly, and we are reminded that markets commonly overshoot.
This vote could increase the odds of a global recession and raises the risk that other countries could contemplate similar moves. Together these factors may increase both the likelihood and magnitude of shorter-term downside risk. At the same time, we don’t believe this vote will materially affect companies’ long-term cash-flow generation.
As we further assess the landscape now that a Brexit is certain, including how central banks, investors, and voters respond, we will make well-informed judgments about the range of possible outcomes and their investment potential. As always, we will evaluate multiple scenarios, weighing long-term opportunities while managing shorter-term downside risk, so that we can then make decisions accordingly.
We have positioned our broadly diversified portfolios for resilience across a wide range of scenarios, including periods of increased volatility. While uncertainty and sharp reversals are inevitable but unpleasant aspects of investing, we emphasize that having the discipline to weather these storms and stay focused on the long-term drivers of investment performance—namely valuations and long-term earnings expectations—is especially important at times like these.
We will provide additional commentary if our assessment results in material changes to our views or portfolio positioning.
Why Is the Market Still Going Up When COVID-19 Risks Remain?
Even as the rate of unemployment remains high, COVID-19 continues to spread in the U.S., and economists forecast a huge drop in economic activity, the stock market continues to rally. We remind our clients that market prices reflect a consensus view about the future and that maintaining a disciplined investment approach is the best way forward.
Why is the Market Going Up When Economic News Looks Grim?
Our clients, and investors broadly, have been asking this important question: How do we reconcile the recent stock market gains, particularly in the United States, with the poor state of the current economy and the weak outlook? In this post, we explain the variables that impact investor behavior and respond to why financial markets can rally in the face of negative news.