Markets were caught leaning the wrong way Thursday night when the UK referendum on whether to stay in or leave the European Union (EU) went in favor of the “Brexit” (i.e. – leave) camp by a 52% – 48% margin of victory.
In the week leading up to the vote, several respectable polls had come out showing the “Stay” camp was comfortably in the lead. Additionally, folks betting with real money in the London parlors confirmed that the “Stay” camp was highly favored to prevail. As such, the S&P 500 Index had rallied a full 3% over the last week, and was very close to new highs for the year. Most pundits were predicting fresh breakouts to new highs once the vote was behind us.
As such, the surprise results gave a shock to financial markets. The British pound plunged, foreign markets sold off hard, and our markets were set to open in negative territory. Although the S&P 500 fell -3.60% on the day, that was a smaller decline than many other foreign markets experienced, leaving our stock market roughly flat for the year.
One of the reasons we have maintained our defensive posture in portfolios is that we expected market volatility to resume at some point. Between the Fed’s proposed rate hikes, the Brexit vote, and the Presidential election, there were plenty of catalysts on the horizon. Yet it’s always hard to see which one will provide the spark. Our defensive posture puts client accounts in a position to weather the storm, and be prepared for opportunities that could surface.
While this weakness could persist short-term, we think our markets will likely stabilize soon. For one, the UK makes up less than 4% of global GDP. Moreover, the Lisbon Treaty gives the UK up to two full years to negotiate the terms of their exit from the EU. So not much will change in the near-term. Also, global central banks have stated that they stand ready to support their markets and provide liquidity. This has been supportive to markets in recent years. Last, this will likely put the Federal Reserve firmly on hold in terms of their desire to raise interest rates in the U.S., at least for several months and possibly longer.
In sum, the strong negative reaction to the Brexit will likely subside in the intermediate-term similar to how most other “crises” have played out in recent years. Our longer-term concern would arise from the possibility that other members of the EU look at this precedent to hold their own referendums and try to follow the UK’s lead. Stay tuned.
Jordan L. Kahn, CFA
Chief Investment Officer