It’s been almost three years since the original United Kingdom referendum vote on June 23, 2016, and still today we are seeing daily headlines contemplating the resolution and how it will affect global economies and financial markets. Now is a good time to refresh our readers as to what this referendum means and how it may impact the markets. Let’s first remember the very negative initial reaction to this vote when it occurred. The chart below is a quick reminder of how poorly this vote was received in the global financial markets on June 24, 2016; the first day of trading after the June 23rd vote:
The United Kingdom EU membership referendum (i.e. Brexit) occurred on June 23, 2016; 51.9% of those voting supported leaving the European Union. This vote started a two-year process whereby the UK would leave the EU on March 29, 2019. This has since been extended to April 12, 2019. The situation today seems as confusing as it was initially over two and a half years ago with many asking, “What might we expect in the coming months and does it matter?”
Is Brexit Already Priced In?
After nearly three years of political wrangling and media headlines, the global financial markets have accepted Brexit. The markets have seemingly priced in the expectations of slower growth for the UK and global economies. Investors that have been allocated to international developed markets, often benchmarked to the EAFE Index (Europe, Asia & the Far East), have felt the market’s discounting mechanism over the past few years. The EAFE index has been a drag on globally allocated portfolios and today’s valuation levels reflect this underperformance. The global slowdown that has hurt EAFE equity returns has been internationally led and the “uncertainty” over Brexit is likely a big reason for this underperformance. The United States financial markets have been the dominant global performers as uncertainties were lower and economic conditions more robust. The chart below shows the performance of major global indexes since the beginning of trading on June 24, 2016 through the close of market on 3/31/19. Clearly the EAFE has been a drag on global performance
The Markets Simply Don’t Like Uncertainty
Brexit, whether it is a soft exit or a hard exit, is likely to be messy. We don’t profess to know all the ramifications, but from a common-sense standpoint, we do know that the financial markets just don’t like uncertainty. When there is uncertainty, decision making for both businesses and consumers slow. When decisions are delayed, or not made at all, investments stall and the result can often lead to economic slowdown. This is what has occurred and the chart below shows that since the referendum, the UK’s GDP slowdown has dragged the Eurozone while the U.S. has continued to expand
Led by UK business stagnation since the referendum:
Perhaps the Removal of this Brexit Uncertainty Helps the Global Economy and International Returns?
We know that we must expect the unexpected with Brexit as this situation has just been extremely complex and all the intertwined trade deals of an exit is daunting to understand. The path forward could go down one of many roads and that may be priced in already. The removal of the uncertainty may allow decisions to be made, stronger business investment, and may even allow for some forward progress. As uncertainties are removed, the global economies are better positioned to succeed. In the meantime, the below chart shows that the U.S. market has become the most expensive given the outperformance of the past number of years. The UK, on a forward P/E basis, trades at 14X earnings which is very reasonable, and it carries a dividend yield of 4%. If growth could resume, perhaps the EAFE index will finally perform!
Brexit is very complex and many more headlines are likely to follow. The chart above shows that the underperformance of the EAFE index and the UK may have priced in this negativity already as valuations reflect the slower growth brought on by this uncertainty. Global economies need more certainty and the hope is that removing the Brexit uncertainty is a step in the right direction towards clarity. Perhaps this will then be followed by a U.S. / China trade deal further removing uncertainty from the global economy. In the meantime, Brexit has been so widely publicized and discussed that the market’s discounting mechanisms have likely priced in the eventual Brexit.
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