Brexit's Effect on the Market

Let’s address the recent United Kingdom Brexit vote and its effect on the markets.

Vote Heard 'Round the World

First, what is Brexit? It is a media-coined term attributed to the recent referendum of the U.K.’s membership of the European Union (EU). The EU is an economic union of 28 member states located in Europe. The members have agreed on a standardized system of laws and the free movement of people, goods and services within. To the astonishment of just about everyone, the UK voted to leave the union by a margin of 52% to 48% in June.

Fear of the Unknown

Second, what does this mean for the markets? The UK vote to leave the EU inevitably triggered an immediate negative reaction in global financial markets, which meant volatility in the short term while the shock of the vote settled in. Beyond that, we feel the markets should be able to withstand the fear and remain range bound for a while. (For related reading, see: Instituting Investing Rules: Lessons from Brexit.)

In our observation volatility stems from a fear of the unknown; volatility tends to abate when the new rules become known. Adjustments will be made according to the new European topography. This is where patience pays off. It will take at least two years for the U.K. to negotiate and unwind from the EU. The upside may be somewhat limited in the near term, but we do not think a bear market is imminent by any means. 

Fed's Slightly Optimistic Outlook

We do not anticipate this to cause a significant tightening of U.S. financial conditions. This could also mean the Federal Reserve Board will refrain from additional rate hikes for the remainder of the year, although no one is quite sure how to read the Fed. At its July 27th meeting, the board once again opted not to raise rates. However, the post-meeting statement noted that "Near-term risks to the economic outlook have diminished." Job gains, a strong labor market and other positive indicators were also mentioned in the statement along with inflation, which is "expected to remain low in the near term," being listed as a negative sign. Once again the Fed avoided committing to what it may or may not do at its next meeting in September.

Keeping Calm

Finally, we understand the anxiety of a volatile market and that the media may heighten said anxiety in their constant search for biting headlines. Still, it is important that investors do not lose sight of the big picture. For a diversified long-term investor with multiyear time horizons, the biggest risk  is to panic and sell at a low price. That is exactly how the individual investor underperforms the market. Furthermore, as with the Brexit downturn, we feel there will be opportunities to take advantage of. The bump in the road will sort itself out and companies and governments will go on.  Fundamentals and earnings will once again be valued over emotions. (For more, see: Behavioral Finance: How Bias Can Hurt Investing.)

So, should you fear Brexit? No. You should let it run its course and not make any rash decisions. However, it is summer and you should fear the sunburn. Break out your SPF, and your sun hat and enjoy some downtime. (For related reading, see: Does Rainfall in Ethiopia Impact the U.S. Market?)