Brexit: What is it and how will it affect your portfolio?

June 21, 2016
 
 
 
 
 
 
 
 

On June 23rd, this month, voters in the United Kingdom will get to say whether or not they want to stay in the European Union. This vote is affectionately known as "Brexit." How will Brexit affect your portfolio?

 

Hello, my name is Paul Carroll. I'm the CEO and founder of Efficient Wealth Management, a boutique wealth management firm based here in The Woodlands, Texas.

 

The Brexit referendum will probably have ramifications for many, many Western economies. What's going on here? Why would Britain vote to leave the European Union (EU)? We've talked a lot about the disgruntled element in Western society. In the United States we're seeing a very polarized election. Throughout the world the same forces that are going on here are conspiring to create unexpected consequences.

 

What are the forces we're talking about? Primarily, technology has created a bifurcation in society between knowledge workers and the rest. The rest are getting left behind. Politically, you could argue why, what to do about it. It really doesn't make any difference. This is a global phenomenon in developed countries, and it is having global repercussions. In England, that repercussion is the Brexit vote.

 

Now, a rational economist would say, "Why on earth would Britain leave the EU? They've got a 'heads I win, tails you lose' deal. They don't use the euro and they get to keep their own currency." They are exempt from many of the European Union's financial regulations, and as such get to enjoy a most favored status for their financial center in London, a status that is very much at risk if the Brexit vote is to leave.

 

They benefit from unfettered access to the entire European Union, and through European treaties, the rest of the world. It is yet to be determined how many of those treaties will stand if they leave the EU.

 

Britain really is well suited for the new multi-speed Europe. It's hard to fathom why the British would do this unless one looks through the prism of the frustration of the working class and lower middle class – the very same prism that we see back here in the United States.

 

How bad is it if Britain votes to leave the EU? The Brexit vote could mean that London is no longer the financial center of gravity in Europe. The loss of treaties, the loss of market access, and more importantly, the loss of the fundamental reason for the European Union: the end of centuries of devastating wars in Europe.

 

Now, I'm not going to say that if Britain leaves the euro and the European Union, all of a sudden Europe will be at war, but certainly the unraveling of the European Union is very much an unintended consequence that may occur.

 

For example, the southern countries along the Mediterranean – Spain, Italy, Greece – they have suffered through significant austerity measures that have been imposed on them by the northern countries. I think most economists would agree that these impositions have been very maladaptive for their economies. Whether or not these measures are justified is water under the bridge; it's hurting them. On the flip side, the northern countries are sick and tired of writing blank checks.

 

The benefits of the euro and the European Union clearly are not without cost, and yet still they are overwhelming in many regards. Of course, the biggest benefit has been uninterrupted peace since the end of World War II. It's easy to forget the value of peace when you get used to it, but we need to remember that we're living in uncertain times. We do not just have Islamic terrorism, but we also have a very unfriendly, hostile Russia living on the eastern border of Europe. This is not the Russia of Gorbachev and the wall falling, this is a Russia of thugs, bullies. This is not a good world order for the European Union to be losing one of its anchor tenants.

 

What does this mean for investors like yourself? How is this going to affect the markets? The fact is, unlike the election in November, where the bookies have pretty well priced in a Clinton victory (whether or not that's something you want to see), on this one it's harder to call. This election is very close, which means the markets don't know how to price it in. They've probably priced in about a 50% probability of a leave vote.

 

Should that leave vote occur, there will very likely be a strong negative market reaction, and history tells us this reaction will very likely be an overreaction. If that's the case, it will be a wonderful buying opportunity for overseas stocks, which are already fairly well priced given the strength of the dollar and the strength of the United States financial markets.

 

We're going to wait until the week after, and we're going to see what happens, but if the British do vote to leave the EU, as remarkable as that sounds given how bad that may be in the long term, there's a great case to say globally diversified foreign stocks are going to be on sale.

 

Thank you, and we wish you the best investing success.

 

 

 

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