“Brexit,” or Britain’s referendum on whether to exit from the European Union, took an unexpected turn yesterday when British citizens, in a narrow vote, decided to leave. Although Britain will remain in the European Union for at least another two years, the uncertainty over the impact of the change has roiled global markets. British Prime Minister David Cameron has stepped down. The British Pound dropped 9% in value, and global markets fell 3 to 9% as analysts assessed the consequences.
Analysts generally agree that the economy of the United Kingdom will not collapse, and neither will the Euro. Nevertheless, the ripple effect of Brexit will be lengthy and broad. Some have compared this to a divorce settlement between Britain and the EU that will take two years to finalize. The immediate financial reaction was a flight to safety in U.S. Treasury bonds, British and German bonds, and gold. Oil fell by 5%, and British bank stocks were down 12 to 14%.
Because the U.S. dollar is suddenly stronger against other global currencies, it could slow the demand for U.S. exports, since they will become more expensive overseas. Morgan Stanley analysts estimate this may reduce U.S. growth by 0.6% over the next two years.¹
A positive outcome of the uncertainty in Europe is that increased interest rates in the U.S. are unlikely. There is even speculation that the Federal Reserve Bank may reduce interest rates. Low interest rates are a stimulus for the stock market and may help to offset the downturn from Brexit. Lower interest rates are also a stimulus for large purchases like homes and cars where an attractive financing rate is a consideration.
The U.S. economy remains fundamentally strong. Existing home prices have hit a 9-year high², and retail sales have had their biggest increases in a year as Americans stepped up purchases of cars and a range of other goods.³
What remains largely unaddressed by the media is the underlying cause of Brexit — unequal economic income and wealth. The economic recovery from the Great Recession in 2008 and 2009 has mostly benefitted only the top 1 to 2% of the global population. The ultra-wealthy have done well, thanks to generous tax breaks, government bailouts and financial manipulation. By comparison, the general population is still struggling, mired in low income, low employment, loss of benefits, high taxes, and stagnant prospects. When the vast majority of the population is forced to fight over crumbs, there can be a growing tendency towards insularity, self-defense, and blaming immigrants who are “different.” What Brexit really reflects is growing resentment against being cut out of economic prosperity and decision-making.
Ironically, the financial markets, although volatile, may be one of the few ways that the middle class can protect itself from economic shocks and inflation, and participate in global economic growth. Since the bottom of the Great Recession in 2009, the Standard and Poors 500 has grown from 735 to 2,107 points, a gain of 187%.
Although today’s one-day drop in the market is shocking at onset, if we take a step back, the market rescinded yesterday’s market boost of 225 points (built up when the market anticipated Brexit defeat) and took us back to our financial position a month ago in May. The Dow is still 1,700 points higher than it stood in February of this year, and 10,000 points higher than it stood at the bottom of the Great Recession. No one likes to take a step back, but occasionally you have to take one step back in order to take two steps forward.
Likely the market will continue to be volatile until the November Presidential elections. As we have seen with past crises, like the tech bubble, the housing crisis and the Great Recession, this is not the time for knee-jerk reactions and panic selling. In the short-term, markets tend to be volatile, but in the longer-term, they are quite resilient and provide reliable growth. The fallout from Brexit is likely to extend for several years, but those who stick to their long-term plans are likely to be rewarded for their patience, and gain from unexpected opportunities.
¹ Washington Post 6/24/2016
² Fox Business News 6/22/2016
³ Reuters 5/13/2016