What is a Brexit and Why Should I Care?

June 20, 2016

Markets have sold off for the past week largely in response to concern that Britain will ‘exit’ the European Union.  The so-called ‘Brexit’ is far from assured with polls showing the ‘stay’ vs ‘exit’ votes too close to call.  If Britain does exit the European Union (“EU”) what does it mean and as investors should we care?

 

To answer that question let’s first take a look at the European Union itself.  Basically, the EU is a treaty between 28 European countries whereby they share free-trade allowing goods, capital, and workers to flow between member countries without customs barriers.  With the exception of Britain, they also share a common currency, the Euro, greatly simplifying international commerce and unifying the region under the European Central Bank.  Most observers believe that the benefits of the EU are significant.  Not only does the EU create efficiencies through a large common market, it also provides a single negotiating block with trading partners such as the United States, China, and Japan, greatly increasing European power through unity.

 

Unfortunately, there are also disadvantages to the EU which create tensions among the member states.  One significant issue in Europe is immigration, and the Brexit camp has emphasized the need for Britain to control its own immigration policies.  Other hot-button issues include the cost of membership, the loss of control to EU bureaucrats, and the overall belief that Britain would be better off without having to ‘carry’ some of the weaker member states.  Finally, there is a general desire within Britain, not unlike the United States, to reject the status quo.  In total the Brexit campaign has been far more successful than most pundits anticipated and is close to winning the referendum this week.

 

Of course, we are simply outside observers to British politics, but as investors, we are keenly interested in how the vote could impact global markets.  The first concern among market participants is what I will call the domino effect.  The loss of a member state as important as Britain is damaging to EU, but more critically it sends a signal to other members that they may be better off on their own.  If Britain can leave the EU then what about Spain, Greece, Italy or others?  Could Britain merely be the first domino to fall in the unraveling of the EU?  The second concern from an economic perspective is the general rise of nationalism and protectionism.   Whether voters and workers agree, there is a general consensus among economists and market participants that free trade increases global economic growth and by extension corporate profits.  If Britain were to exit the EU then the free trade between Britain and the EU could be at risk.  The EU is already warning (perhaps bluffing) that if Britain leaves the EU, British companies would not have open access to the European common market.   Similarly, President Obama threatened that if Britain left the EU, then Britain would be at the ‘back of the line’ for trade deals with the U.S.  The concern to investors is that the friction caused by trade regulations could damage British companies and slow global growth.  The final concern from a market perspective is simply uncertainty.  Markets don’t like uncertainty and have reacted negatively to an uncertain future.  If Britain leaves the EU then what laws and regulations will take the place of the known status quo?  Granted, change is not necessarily negative but an uncertain future can scare investors away for a time.

 

It is important to note that even a successful Brexit vote would not result in an immediate British exit from the EU.  Member countries must notify the EU of their intent to leave and have 2 years to negotiate how to exit the treaty.  Similarly, a British vote to remain in the EU could simply be revisited in 2 years.  With the vote too close to call there are certainly many unknowns on how the future will unfold.  As investors, we are watching the vote for risks and opportunities, but we also remain confident in our investment discipline and do not feel the need to ‘bet’ on the outcome this week.  We have had a bias toward the U.S. for more than a year and are comfortable with our European exposure.  If you would like to discuss your portfolio, please give us a call.

 

 

Oltermann, Philip. "No single market access for UK after Brexit, Wolfgang Schäuble says." theguardian. http://www.theguardian.com/politics/2016/jun/10/no-single-market-access-for-uk-after-brexit-wolfgang-schauble-says.
 

Hutton, Robert and Sink, Justin. "Obama Says Brexit Would Put U.K. at Back of the Line for Trade Deals." Bloomberg. April 22, 2016. http://www.bloomberg.com/politics/articles/2016-04-22/obama-says-u-k-would-be-back-of-line-for-trade-deal-post-brexit

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