The British are Leaving

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In a historic referendum this week, a (thin) majority of the British electorate have decided to leave the European Union.  The EU and its predecessor organizations was formed in 1950’s as an economic and political cooperation zone intended to promote free trade and lower the potential for military conflict that had ravaged that part of the world in prior decades.

Over time, the EU has helped economic and capital market growth by making commerce among member countries free of tariffs and by providing open borders throughout the region for citizens of EU countries.  To its credit, the EU helped European industry be more productive and efficient.  Yet the trade block is also notorious for its unnecessary regulations and, in recent years, its requirement that better-run countries (like the UK and Germany) back the financial bailout of poorly-run countries (like Greece).  The current large-scale refugee crisis has exacerbated already simmering tensions.

The economic and market impact of the UK’s exit from the EU is uncertain.  But we would consider this development as unlikely to serve as a catalyst for a near-term global recession or 2008-style implosion of capital markets.  To put matters in perspective, the UK is 3% of the global economy, and American companies as a whole derive less than 5% of their earnings directly from it.  Including second-order effects, especially on the European economy, we expect a negative but modest impact on global growth and corporate earnings from Brexit.

The British referendum is symptomatic of broader issues facing much of the developed world.  Slow growth and ineffectual (perhaps counterproductive) government policies have led to a rejection of the political status quo.  Voters are more willing to roll the dice on policy and candidates.

For investors, higher political uncertainty adds to the premium one should demand from risk-bearing assets.  And it is part of the rationale – in conjunction with a challenging valuation, earnings, and monetary policy environment – behind the conservative posture we’ve taken in in client accounts, where an inclusion of cash, stable yield securities, and gold help protect capital.

We’ll provide a broader discussion of investment strategy in our quarterly letter in a few weeks.  Meanwhile, please contact us with any questions you may have.  We welcome your call.

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