Newsletter: Brexit

GLOBAL MARKETS

Last Friday, a much anticipated United Kingdom (UK) referendum voted to discontinue membership in the European Union (EU) after 43 years(i), by a 52-48% margin with over 70% of eligible voters casting ballots(ii). The EU as a trading block is larger than the US(iii), comprises 28 European countries and the UK would be the first to leave the EU(iv). The UK is the second largest member of the EU by both population and gross domestic product(v). The announcement to move out of the EU by the (UK) has ignited volatility in markets around the world that will likely continue in the short-term until its impact is fully assessed by other global markets. The vote surprised many with markets advancing during the prior week as polls in the U.K. showed that a majority of voters favored staying part of the EU.    

All major global markets and currencies, except the US Dollar, fell on the news(vi). The Prime Minister and leading advocate of the UK remaining in the EU, David Cameron, has announced he will resign in the next few months so that new leadership can be chosen by the citizens of the UK to direct the country into this new era(vii).  Some economists and financial analysts believe it could be two years or more for the UK to formally leave the 28-nation bloc.  It remains unclear how the country’s relationship with the EU and each of its member nations, as well as with other major global trade partners, will change during that period(viii)

POLITICALLY & ECONOMICALLY

Great Britain became part of the European Union in 1973 before the name was formally adopted and its regulatory powers expanded(ix). Ever since then, many within the UK complained that being a part of the EU seeded too much sovereignty to Europe; years later when the euro as a currency was implemented, the UK opted to stay with the British Pound instead of the new common Euro currency(x).  Exit polls reveal that UK voters were most worried about a loss of national identity as a result of the amount of immigration that has hit their country(xi).  Immigration and what welfare benefits they receive should be sovereign decisions as voiced by UK voters in favor of leaving the UE(xii). 

The UK voters went against all five major political parties, more than 1,200 FTSE 100 corporate CEOs, major banks in the UK including the Bank of England, as well as various heads of states and UK academic institutions who all favored remaining part of the EUxiii.  President Barak Obama stated in April when visiting London to pledge his support for the UK remaining in the EU, that you (UK) “would go to the back of the queue” in future trade negotiations with the U.S.(xiv).  Economists are mixed.  Currently, 50% of Great Britain’s total trade is within the European Union and that will be affected, as will London’s role as a major world financial center.  However, there are two schools of thought how this might play out. Proponents who wanted the UK to leave the EU had contended that the U.K. would benefit by the elimination of costly EU regulations and by controlling immigration into their country(xv), thus enabling the world’s fifth largest economy to sign new trade agreements with its trading partners(xvi).  The vital task of the new independent UK will be to focus on gaining access through new negotiation to the single EU market, as this currently represents almost half of UK exports(xvii).  Opponents of the UK exit from the EU cautioned that leaving the EU would irreparably harm the U.K. economy by abandoning long-held trade, financial, legal, and immigration agreements that provide for the free movement of people and capital within the EU(xviii).  

Additionally, the other unknown at this point is whether other countries may also want to leave the EU(xix).  The UK as a single event is relatively small in a global context; therefore, the question of contagion is actually more important(xx).  The European and other global central banks have indicated their willingness to provide liquidity if needed(xxi).  The prospect of a U.S. rate hike has diminished for the remainder of this year, further providing liquidity to markets(xxii).

Many economists describe Friday’s market sell reaction as more of a surprised environment than a truly distressed one(xxiii) and may in the end be advantageous for the US.  The UK may emerge as a stronger ally for the United States as we can negotiate a new stronger trade and financial agreements.  The US may be able to align more closely with our ally in challenging world aggression and global terrorism(xxiv).           

TIMELESS INVESTMENT PRINCIPLES

Market declines are inevitable and do not last forever.  We expect higher long-term returns on stocks than we do from cash and bonds, and for that, we also expect greater volatility based on historical data.  Over the past 114 years, market declines of 10% occur about once every 115 daysxxv.  The last time we experienced a pullback in the U.S. stock market of this magnitude (10% or greater), prior to August 2015, was in October 2011(xxvi).  The average length of a 10% correction is about four months(xxvii) before prices begin to return to previous levels.  Market declines of 15-20% occur on average every 2-4 years(xxviii) during the prior 115 years.  Declines can sometimes cause imprudent behavior by filling and consuming investors with dread and panic.  History has shown that stock market declines are a normal part of the investment cycle.  Market declines have varied in intensity and frequency, but the market has always recovered from declines.  Although past results don’t guarantee future results, remembering that downturns have been temporary in the past may help quell your fears(xxix).

Short-term market timing does not work.  Short term market timing is the elusive “holy grail” or “fountain of youth” of investing—something you want very much, but that is very hard or impossible to get or achieve.  If anyone could do it consistently—sell right before something goes down, and buy right back before it goes back up—the rewards would be great, but typically investors end up with sub-par performance due to the extreme difficulty with getting the short term timing (day trading) wrong(xxx).  Although the Holy Grail/Fountain of Youth most likely does not exist, the benefits of a long-term disciplined investment plan are compelling, but the generally higher returns associated with investing in stocks over the long-term is dependent on sticking with your investment plan through both good and bad times in the markets.

The importance of diversification. After studying the most brilliant and successful minds in the investment field over the past 28 years—both past and present—the one vital and common lesson learned is that diversification through asset allocation works to mitigate volatility over the long-term by diversifying into separate asset classes with varying correlation to one another.  We were taught as youngsters by our parents and grandparents “don’t put all your eggs in one basket” which is a straight forward translation to allocate your investment funds into different asset classes within your portfolio.  The idea is that they all don’t go up or down at the same time—and this could not ring louder at this time.  While this may not be the case on a day-to-day basis, a mix of different types of assets provides asmoother and more stable ride for your portfolio over the long-term(xxxi).  However, investment disciplines do not work all the time in every economic environment.  In fact, in a recent Bloomberg News article, it was argued that asset allocation in 2015 had one of the worst results in nearly 80 years with most major asset classes finishing the year with tepid results, with no asset class offering superior relative returns to lift the overall diversified asset allocation portfolio return(xxxii).

OUR GAMEPLAN

Our LW Portfolio Models are not immune to declines in global markets as we experienced on “Brexit Friday”.  We do not have a crystal ball nor do any of the market analysts and forecasters.  Our belief is that our LW Portfolio Model construction has positioned us for potential resilience in this environment and has also positioned us to possibly take advantage of market mispricing.  We see no need to change course, as the ancient buddish proverb states “If we are facing in the right direction, all we have to do is keep on walking”.  

Our Leshnak Wealth Portfolio Models are globally diversified and strategically constructed, with a tactical component.  We have a bias toward value which prescribes a requirement for dividend yield from our investment positions.  In simple terms, we have investment positions in eight asset classes: domestic equities, foreign developed stocks, foreign emerging market equities, domestic bonds, foreign bonds, cash equivalents, commodities, and real estate.  How much of each asset class (if any) we hold in the aforementioned asset classes is based on your unique risk tolerance, financial resources and personal goals and objectives. Moreover, we have a portion of each portfolio that is tactical and flexible.  This allows the manager to move assets into the sector(s) that best fit current market conditions based on their methodology.  Our portfolio construction has two other vital components—we want dividends from each position so no matter what the market is doing day to day, we still have a dividend coming into the portfolio for income or to reinvest.  Lastly, we overweight value versus growth in our allocation models which we believe puts us in the position of the “turtle”, in the proverbial tortoise verses the hare scenario, over the long-term with equities.

As your financial fiduciary, the Leshnak Wealth team cares deeply about your financial well-being, and will monitor for rebalancing opportunities that may add value to your portfolio, or to be defensive as conditions might warrant.  As always, please call with questions or if you wish to discuss your specific portfolio in greater detail.

–Bob Leshnak, June 27, 2016

The investment decisions are those of Robert M. Leshnak, Jr., CLU, ChFC, CFP®, MS, EA as of 6/27/2016 and are subject to change.  The information contained herein is only intended for Leshnak Wealth clients invested in the Leshnak Wealth Portfolio Models.  No forecasts or recommendations are guaranteed.  The technical data utilized as part of the investment decisions does not guarantee future positive results. Performance, especially for short periods of time, should not be the sole factor in making investment decisions.  The information contained herein does not constitute client specific investment advice or take into account a specific client’s particular investment objectives, strategies, tax status, resources, or investment time horizon. No investment strategy such as asset allocation, diversification, tactically overweighting sectors, or utilizing fundamental and technical analysis can always assure a profit, nor always protect against a loss.  The information presented is not intended to be a substitute for specific individualized tax, legal, or financial planning advice.  The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.  Investing involves risks in regards to all of the investment products mentioned in this commentary, including the potential loss of principal.  International investing involves additional risks including risks associated to foreign currency, limited liquidity, government regulation, and the possibility of substantial volatility due to adverse political, economic, and other developments.  The two main risks associated with fixed income investing are interest rate and credit risk. 

Typically, when interest rates rise, there is a corresponding decline in the market value of bonds.  Credit risk refers to the   possibility that the insurer of the bond will not be able to make principal and interest payments.  Investments in commodities may entail significant risks and can be significantly affected by events such as variations in the commodities markets, weather, disease, embargoes, international, political, and economic developments, the success of exploration projects, tax and other government regulations, as well as other factors.  Indexes are unmanaged and investors are not able to invest directly into any index.  Past performance is no guarantee of future results.  Please note that individual situations can vary.  Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.                                             

i AllianzGI Perspective: UK Votes Leave, “With the UK electorate voting to leave the EU, investors will need to brace themselves for the political, economic and market impact of this watershed moment.”, June 24, 2016. ii Gross, Jenny. “U.K. Rejects European Union”: The Wall Street Journal, June 24, 2016. iii Green, Byron.“Will it be Brexit, or another dodged bullet?”; Green Investment Management Market Commentary, June 20, 2016. iv Fidler, Stephen, Pop, Valentina and Gross, Jenny. “World Leaders Grapple with Impact of an EU Exit by Britain; Cameron Steps Aside”: The Wall Street Journal Weekend, Sat/Sun June 25-26, 2016. v Green, Byron.“Will it be Brexit, or another dodged bullet?”; Green Investment Management Market Commentary, June 20, 2016.

vi Gold, Riva, Bird, Mike and Otani, Otani. “U.K Vote Sets Off Shockwaves: Stocks, Currencies Take Hard Fall”: The Wall Street Journal Weekend, Sat/Sun June 25-26, 2016. vii Fidler, Stephen, Pop, Valentina and Gross, Jenny. “World Leaders Grapple with Impact of an EU Exit by Britian; Cameron Steps Aside”: The Wall Street Journal Weekend, Sat/Sun June 25-26, 2016. viii “U.K. Vote to Leave European Union Roils Financial Markets, But Process Will Be Lengthy and Outcome Likely Not as Bad as Markets Fear”; American Funds Market Commentary June 24, 2016.

  1. “U.K. Vote to Leave European Union Roils Financial Markets, But Process Will Be Lengthy and Outcome Likely Not as Bad as Markets Fear”; American Funds Market Commentary June 24, 2016.

  2. “U.K. Vote to Leave European Union Roils Financial Markets, But Process Will Be Lengthy and Outcome Likely Not as Bad as Markets Fear”; American Funds Market Commentary June 24, 2016. xi Baker, Gerald. “Britain Fires a Shot Heard Round the World”: The Wall Street Journal Weekend, Sat/Sun June 25-26, 2016. xii Wesbury, Brian S., Stein, Robert and Elass, Strider, “Brexit is Freedom”; First Trust Monday Morning Outlook, June 6, 2016 xiii Baker, Gerald. “Britain Fires a Shot Heard Round the World”: The Wall Street Journal Weekend, Sat/Sun June 25-26, 2016. xiv “U.K. Vote to Leave European Union Roils Financial Markets, But Process Will Be Lengthy and Outcome Likely Not as Bad as Markets Fear”; American Funds Market Commentary June 24, 2016. xv “U.K. Vote to Leave European Union Roils Financial Markets, But Process Will Be Lengthy and Outcome Likely Not as Bad as Markets Fear”; American Funds Market Commentary June 24, 2016. xvi Gardiner, Nile. “Why Americans Should Celebrate the Brexit Vote”; The Daily Signal-Heritage Foundation: June 24, 2016.

    xvii First Eagle Insights; “After Brexit”; First Eagle Investment Management Market Commentary, 6/24/2016. xviii “U.K. Vote to Leave European Union Roils Financial Markets, But Process Will Be Lengthy and Outcome Likely Not as Bad as Markets Fear”; American Funds Market Commentary June 24, 2016.

    xix Hasenstab, Michael, Templeton Global Macro Portfolio Update in light of the UK vote to leave the EU; 6/24/2016. xx First Eagle Insights; “After Brexit”; First Eagle Investment Management Market Commentary, 6/24/2016. xxi First Eagle Insights; “After Brexit”; First Eagle Investment Management Market Commentary, 6/24/2016. xxii Hilsenrath, Jon, and Douglas, Jason, “Prospects for early Fed Rate Increase Recede”; The Wall Street Journal; June 25-26, 2016.

    xxiii First Eagle Insights; “After Brexit”; First Eagle Investment Management Market Commentary, 6/24/2016. xxiv Gardiner, Nile. “Why Americans Should Celebrate the Brexit Vote”; The Daily Signal-Heritage Foundation: June 24, 2016. xxv “Keys to Prevailing Through Stock Market Declines”; American Funds Investor Resource: A Guide to Market Fluctuations; Aug. 2015; americanfunds.comxxvi “Keys to Prevailing Through Stock Market Declines”; American Funds Investor Resource: A Guide to Market Fluctuations; Aug. 2015; americanfunds.comxxvii “Keys to Prevailing Through Stock Market Declines”; American Funds Investor Resource: A Guide to Market Fluctuations; Aug. 2015; americanfunds.comxxviii “Declines Have Become Common and Temporary Occurrences”; American Funds Client Conversations; Jan.

    2016

    xxix “Keys to Prevailing Through Stock Market Declines”; American Funds Investor Resource: A Guide to Market Fluctuations; Aug. 2015; americanfunds.comxxx Vanguard Principles for Investing Success; 2014, pages 29-32; vanguard.com xxxi Vanguard Principles for Investing Success; 2014, pages 8-16; vanguard.com xxxii “The Year that Stocks, Bonds and Cash Failed to Thrive”, Investment News, January 4, 2016.