Divorces are often messy. The referendum vote for the UK to leave the EU was a bit of a surprise; at least for those who understood the fear it could create. If there are two things that financial markets dislike most, its surprise and uncertainty. Unfortunately, the vote to leave has welcomed both of those factors. So what does it mean and what do we do about it?
What does it mean?
Great Britain (England, Wales, Scotland and Northern Ireland) voted via a public referendum on whether to leave or remain in the European Union. Obviously you know by now the public voted to leave. Great Britain must now untangle itself from 43 years of membership in the European Union (EU). Many details have to be revisited, from renegotiating trade agreements to regulations on air space for aircraft. It will take years for officials to address the intricacies. The referendum vote itself has no legal implications. The next step to formally signify Great Britain’s exit is for the (now resigning) Prime Minister, David Cameron, to formally file for the United Kingdom (UK) to exit the European Union. This also may be delayed in the short term for political and economic reasons. The UK will certainly see some headwinds to economic growth, largely as a result of needing to renegotiate terms with its major trading partners (the UK exports nearly 45% of goods and services to EU member countries). The EU is also unlikely to be lenient in negotiations, as the exit brings up more questions about the sustainability of the EU itself, and whether other members should follow suit.
We’re already seeing a significant drop in the UK currency, the pound sterling, by about 10% to a 35 year low, the day following the vote. While this is painful for UK residents in the short term and will likely create some inflation concerns, the silver lining is that it will make exports more competitive in the long term. The fact that the UK never shared the Euro currency actually makes things quite a bit easier. If Greece had exited for example, it would have been much messier.
The UK’s GDP only makes up about 4% of global GDP. So by itself, the exit isn’t enough to create an economic ripple effect across the world. There is also no real direct impact on the US market or economic growth. However, the uncertainty of the impact of the exit will likely lead our Federal Reserve to give pause to consideration of additional interest rate hikes in the short term. We will continue to see more volatility as the market digests what the long term implications of the exit are. Any unsavory economic or political developments are likely to whipsaw the financial markets.
What do we do?
When discerning what to do in this environment, sometimes the better question to ask is, “What shouldn’t I do?” Here are a few points on what not to do:
- Don’t make any major short term reactions. You should have a long term strategic plan in place and unless personal circumstances dictate, you shouldn’t make any significant changes to your plan.
- Don’t pay too much attention to the news. Firstly, you have no vested economic interest in TV ratings. Second, continually exposing yourself to stressful stimuli won’t make the market go up. Fear is rarely a productive emotion when it comes to investing. Instead try focus on the big picture, and what this has to do with your long term goals.
When thinking about what one can do, the following queries should be considered:
- Do I have the right risk tolerance guiding the portfolio I have in place?
- Is my risk tolerance likely to change in the near future due to a life event (retirement, large home improvement, college expense, inheritance, etc.)?
- Do I have an adequate cash reserve in place?
- Do I have a long term outlook for a portion of my portfolio to take advantage of any opportunities this may create?
Not to be redundant based on past communications, but if you have a financial plan, a diversified portfolio and an appropriate risk tolerance, you should stay the course and rebalance your portfolio. The decisions in these key areas directly translate to your investment experience. There will always be something that gives the market a reason to capitulate, which is why risk management and proper planning at the outset, is your best defense against uncertainty and surprise.