Brexit and Your Portfolio

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If you follow the financial world closely, or let’s face it, if you’ve been half awake over the last couple of weeks, you have heard all you ever wanted to hear about “Brexit.” Listen to one pundit and it’s the end of Europe and the civilized world as we know it. Listen to the next and it’s the greatest advancement for democracy since Cleisthenes (you probably haven’t heard of him but he’s considered the “father of democracy” so the analogy works!) Remember that every talking head on T.V. has some bias and personal interest that they are protecting. Let’s discuss what it really means to the average investor.

Nothing has changed!

The people in the U.K. voted on a non-binding advisory referendum that is merely a suggestion to the government. While I believe the government will follow through, there is a lot of posturing going on right now. In reality, to leave the EU, the U.K. must file paperwork (which they have yet to do) and at that point they will have two years to leave the EU. So we are at least two years away from the actual Brexit. There is a lot that will happen between now and then.

But what about the fact that Standard and Poor’s downgraded the UK’s long-term credit from AA+ to AA? Do you remember when the US credit was downgraded? I’m guessing most people don’t! In 2011, S&P downgraded the US credit for the first time ever from AAA to AA+. On that day, the Dow Jones plummeted 635 points or 6.7% to fall below 11,000. That move, according to The Wall Street Journal “Ignite(d) a global selloff!” Does that sound familiar? (See this headline if it doesn’t.) Since that day in 2011, the Dow Jones has risen to 17,949 as of July 1, 2016.

We’ve been through worse

Even if Brexit is bad, we’ve been through far worse and our economy hasn’t imploded. Let’s talk about the last few crises we have been through. The biggest that comes to mind is Greece. This was the single largest default in history by a government. Our economy survived. Early in 2016, we were faced with the economic slowdown of China. So far, our economy hasn’t imploded. Then there have been a couple of oil collapses, which shook the markets and even almost destroyed our supply of donuts! (“An Unlikely Victim Of Oil’s Collapse: Krispy Kreme”) Our economy survived. Most recently, this week, Puerto Rico defaulted on its debt obligations. This default will impact 19 of 20 oppenheimerfunds municipal bonds. So far, our economy has survived.

Brexit is not a 2008 financial crisis. 2008 was a true crisis that has since framed our view of every dip and correction in the market. Every time there is a drop of any size, the drums begin to beat and every blog and interview talks about the next big coming crash. My favorite quote is from Paul Samuelson who said, “Wall Street indexes predicted nine out of the last five recessions!” No doubt, sooner or later they will be right. At some point in the future, whether a year from now, ten years from now or twenty years from now, there will be a big drop in the market. At that time, every financial expert who has predicted every one that hasn’t happened will cheer for how right they were.

It won’t overly impact the United States

The UK accounts for 3.1% of US Exports and just 2.3% of imports. The total United States GDP in 2015 was $17.9T. The total UK GDP was just $2.8T (the total EU was $18.5T), so the U.S. will have little trouble negotiating a favorable trade agreement with “our indispensable ally” (Paul Ryan). In fact, chances are we will end up with a free trade agreement. And more importantly for the U.K., despite all the posturing of the EU right now, the U.K. will most likely have little trouble negotiating favorable trade agreements with the EU.

But Its Uncharted Waters

One of the warnings you keep hearing is that no country has ever left the EU before so these are uncharted waters. While this is true, several countries exist in Europe and have survived well, having never been in the EU (most notably, Switzerland and Norway.) So models already exist for establishing relations between the U.K. and the EU. My guess is that we will learn everything we ever wanted to know about “The Norway Model” over the next couple of years.

So What Should the Average Investor Do?

The largest risk with Brexit is default. The EU has worked to backstop or guarantee the government debt of weaker member countries. Without the support of Great Britain this will be more difficult. The U.K. contributed 12.57% of the EU budget in 2015. With this in mind, keep an eye on financial institutions in your portfolio.

If the market volatility is truly of concern, speak with your advisor to 1) review your exposure to UK and European markets and 2) as always, ensure that your portfolio matches your risk profile. This is a good time to look at your portfolio and see how you are performing relative to the market. Are you completely exposed to all the ups and downs or are you hedged against some of the downside?

Most importantly, have patience and stick to your investment strategy. In his book “What Works on Wall Street,” James O ‘Shaughnessy’s main premise is that the key to outstanding long-term performance is to “slavishly” stick with your strategy. Many investors lack the fortitude that this requires and fall victim to every latest looming “crisis” like Brexit. This inevitably leads to the dreaded buy high and sell low cycle. Take Brexit for what it is, one of many macro events that, while politically important, should not cause panic in the markets or your portfolio.