What is "Brexit" and why did it happen?
Brexit (short for “British Exit”) was the nickname given to the movement to persuade the British government to pull Britain out of the European Union (EU). A nationwide referendum — only the third in modern history in Britain — took place on June 23, 2016, and by a close vote of 52% to 48% British voters asked their government to negotiate a deal to leave the EU.
The idea of creating a single, common market across Europe began in the aftermath of World War II. A slow effort, but by 1993, a single market was created covering 28 countries. Borders were opened and visas for travel and work permits abolished. An important milestone was the development of the European Monetary Union in 1999 which, by 2002, had converted 19 of the 28 countries (defined as the “eurozone”) over to a single currency, the euro. Britain was a party to the EU, but it did not choose to participate in the eurozone, and thus preserved its use of its home currency, the pound.
While Britain, like most of the other EU countries, benefited economically from a common market, Britain has never been as comfortable with some of the political aspects of the EU. Long-term immigration trends and their recent acceleration under the EU have stoked strong nationalist feelings in Britain, leading to the political movement to exit the EU.
Markets don’t like to be surprised. For weeks polls (and other prediction markets, such as bookies) suggested that by a narrow margin voters would opt to keep the U.K. in the EU. When the opposite happened, global markets reacted negatively.
Unusual market events, such as the Brexit vote, are actually “normal,” but not necessarily frequent. Here’s what we know today: The “Brexit” will take two years, or more, to complete. A number of economically successful European countries, such as Switzerland and Norway, are not members of the EU. We cannot predict which countries will do well and which will not, nor which securities will benefit and which will decline. And despite what some prognosticators claim, no one knows exactly what the future holds in store. However, based on historical events, we believe that these kind of events eventually assimilate within a window of anywhere from 2 weeks to 6 months.
A few things to keep in mind:
1. This is a prime example of market efficiency in action. Well-functioning markets quickly assimilate new information into securities markets. Also, given the unprecedented nature of this event, new information will likely continue to be assimilated into securities markets as the U.K. negotiates the terms of their exit from the EU.
2. Patient investors who ride out such volatility events tend to experience higher long-term wealth accumulation than those who seek to predict and act upon the start or the end of such events. Given the efficiency of global financial markets, reacting to the events after they have occurred only ensures that a portfolio repeatedly “buys high and sells low.”
3. Rebalancing can make a difference. By rebalancing portfolios regularly, we strive to “buy low and sell high” as we focus on making sure each portfolio stays allocated to the desired long-term mix of stocks and bonds.
4. Great risk brings the potential for higher expected returns. While many commentators are focusing on the increased expected risks of investing in the U.K. and Europe, they are ignoring the potential for increased expected returns. When an investment’s risks rise, investors should expect the return potential to rise as well.
5. Political risks are not the same as investment risks. For example, the top performing global market over the last 10 years was the Philippines, which has experienced political turmoil as well as an active guerilla insurgency. On the other hand, a peaceful, stable country like Canada was all the way down at 30th in terms of performance.
Our advice in the face of such events is to take comfort in the longer run of history, which has faced far worse volatility aggravating events than this, including several recessions, stagflation, the Great Depression and two world wars; take time to reevaluate your personal risk tolerance and financial goals before making any changes to your portfolio.
Diversification neither assures a profit nor guarantees against loss in a declining market. All investing involves risk. Principal loss is possible. Charleston Investment Advisors is part of The Wealth Management Alliance LLC, a registered investment adviser. TW 16-008 (06/18)