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How the Market Works

Brexit and Your Investments:  How the Market Works

Posted by kdadmin on June 23rd, 2016.

Brexit and Your Investments:  How the Market Works

While the official Brexit vote tally won’t be done for another 10 hours (~ 3am in the UK), there are a few things you should know …

“Leave”Has a Point

Comparing the UK with the EU is tough for a number of reasons. But currency valuations can be a good way to do it. Look at the blue line in the chart above. It represents the US Dollar priced in British Pounds Sterling. Over the last five years, look at how the dollar has increased in value against the pound sterling. This means that the pound sterling has decreased in value nearly 13%. Now look at how the dollar has increased in value against the Euro. It’s a whopping 28%.

Here’s the takeaway. The UK’s economic power may be eroding against a super strong dollar, but it’s doing so at less than half the rate of the Euro. Although, leaving will likely devalue the pound by 10-11% because of market uncertainty …

“Stay” Also Has a Point

It has been estimated that if Britain leaves the EU, it’s GDP growth will be cut in half. This is because it will no longer enjoy free trade with the EU in the way that it does currently.

Isolationism rarely proves to be the best policy in any government relations. (The USA learned this at the beginning of the 1900’s.) Given that the EU represents a full 50% of Britain’s trade, rattling that cage seems awfully stupid to me.

It’s Not That Simple

Even if the UK votes to leave the UK, such a vote will still have to be ratified by the remaining EU member states. Further, a departure “package” or agreement will have to be negotiated. Another vote could even be required.

In other words, estimates indicate that even if the UK votes to leave today, it will likely take 2+ years for the UK to be fully “out” of the EU.

How Does Brexit Affect the USA?

If the UK votes to leave, it could find itself in a recession. Current GDP is around 2% and the impact of a departure could cause as much as a 4% drop in GDP. While consensus estimates put the drop in the pound sterling at 10-11%, it could drop as much as 30% against the dollar.

Such a drop in the value of the pound sterling against the dollar could essentially kill our exports to the UK. Think of it this way. If you’re living in London, and all of a sudden products from the USA increase in price by 30% (because your currency has dropped in value), are you more likely to pay the higher price or find a local substitute?

A weaker Europe, a weaker UK, softer economies and currencies would likely further exacerbate issues here in the USA. It’s likely the Fed would put off another interest rate hike even if employment numbers were good. With a strong dollar and weakening demand from our UK and European customers, US companies could see a further decline in sales.

Brexit and Your Investments

If US companies see a further decline in sales, it will be much harder to support the current sky high valuations. Add ina rising interest rate market, and more money being pumped out of the economy by the Federal Reserve, and we could see a UK vote to leave being yet another catalyst for a long overdue stock market correction. Which, wouldn’t be all bad.

Unless, of course, you’re heavily invested in stocks …

What You Can Do About It

Stay out of stocks. Consider bonds. Learn about which bonds in this article, “One Year Later, Bonds are the Winner: How the Market Works.”

Remember, having plenty of money in cash and other defensive investments can set you up for great opportunities when the market tanks and others are selling out at the bottom.

This is what we did in January, and it paid off handsomely. You can learn about that here.

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