On June 23, citizens of the United Kingdom voted to leave the European Union. While there has been much speculation leading up to and since the vote, many of the longer-term implications of the referendum remain unclear, as the process for negotiating what a UK exit may look like are just beginning.

• The referendum is non-binding, but will likely lead the British government to invoke Article 50 of the treaty that established the EU. Article 50 gives a country two years to negotiate a future relationship with the rest of the EU and must be invoked by the British Parliament.
• Prime Minister David Cameron, a staunch supporter of the ‘Remain’ campaign, has announced his resignation.
• The UK would be the first country to leave the modern-day EU.
• Central Banks had prepared for this outcome and are ready to act as a liquidity provider as necessary.
• A settlement between the EU and Britain on the open immigration issue (a major force behind the leave vote) could occur before membership is officially withdrawn.

The market action on Thursday showed that there was a strong belief the UK would stay in the European Union (see 5-day chart below). The interesting part was that the polls were very tight. The margin of error was tight but there was a lot of betting going on Thursday believing that the UK would stay. Whoever was betting ended up on the wrong side of that trade and selling prevailed as those trades were unwound.

5-day action (6/20-6/24)

One Year (2015-2016) – A lot of volatility with very little movement

We urge caution in allowing market movements to impact long-term asset allocation. Long-term investors recognize that risks and uncertainty are ever present in markets. A drop in prices is generally due to lower expectations of cash flows, higher discount rates, or both. In some cases, a drop is also due to investors demanding liquidity. In the current situation, some investors and economists may expect lower cash flows due to possible trade barriers that may not be implemented. Higher discount rates may be occurring due to uncertainty about changes in the economic landscape and regulations. We have seen markets increase discount rates in times of uncertainty before, resulting in lower prices and increased expected returns. However, it is difficult to know when good outcomes will materialize in the future. By attempting to time the right moment to invest or redeem, one risks not enjoying the potential benefits of such materializations. Many of those who exit the markets miss the recoveries. What we have often seen in the past is that investors who remained in well-diversified portfolios were rewarded over time.

The UK will have up to two years to negotiate a withdrawal, during which time it remains subject to EU treaties and laws. Any potential operational changes depend on what path the UK and EU decide to take. We actually see this as a positive for the UK as they potentially removed a whole lot of red tape. On the plus side it appears that the Fed will not be raising rates any time soon. Lower rates are a friend of the stock market. As Warren Buffet said, “be fearful when others are greedy and greedy when others are fearful.” This volatility could be a great time to get cash to work.

Morgan Christen, Chief Investment Officer

Disclosures

* Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio.

CPI data are available from the US Bureau of Labor Statistics. Stock is the capital raised by a corporation through the issue of shares entitling holders to an ownership interest of the corporation. Treasury securities are negotiable debt issued by the United States Department of the Treasury. They are backed by the government’s full faith and credit and are exempt from state and local taxes. The indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results, and there is always the risk that an investor may lose money. Diversification neither assures a profit nor guarantees against loss in a declining market. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities mentioned. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.

Disclosure

The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities mentioned. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.