On June 24th, the world awoke to a significant decline in global equity markets. The culprit was not another subprime fiasco, a bank failure, a terrorist attack, or even a government default. The cause of this worldwide sell-off was the decision by the United Kingdom to leave the European Union (EU) – “Brexit.” In 2013, British Prime Minister, David Cameron, agreed to hold a referendum to determine the United Kingdom’s membership in the EU, violating the cardinal rule of politics: Anything important should never be left to the vote of the people. Soon after it became apparent that the referendum to leave the EU had passed, Google’s top searches coming from the United Kingdom were: “What does it mean to leave the EU?” “What is the EU?” “What will happen now that the UK is leaving the EU?” indicating that citizens of the UK finally began to ponder the true impact of the referendum, as they were having “Bregret.”
The European Union is a geopolitical/economic union amongst 28 member states that aims to ensure freedom of movement for its citizens, goods, services and capital, and whose member countries all abide by the same system of laws. A citizen of the EU has the freedom to search for a job in another EU country without needing a work permit and enjoys equal treatment with nationals in regards to employment, working conditions, and all other social and tax advantages.
Many believe that the UK’s “Brexit” was predicated solely on immigration: The increased competition for domestic jobs and the additional stress it was putting on government services. Nigel Farage, leader of the UK Independence Party, has argued that migration of low-wage workers from Eastern Europe “has depressed wages for native-born Britons.” However, figures from the United Nations indicate that the majority of the jobs being filled by these “low-wage workers” have been in the industries of construction, plumbing, nursing and housekeeping of which there are shortages of workers. A recent study by Britain’s National Institute of Economic and Social Research found that EU immigration had increased the country’s Gross Domestic Product (GDP) and lowered the cost of government services, such as healthcare and pensions, which, in turn, helped reduce taxes.
The “Brexit” was not a referendum on immigration but a reaction to the years of economic pressure being applied to the British middle class. For over ten years, the British blue collar workers have been continuously squeezed between declining job opportunities, stagnant wages, and rising health care, food, and education costs. The cause of decreasing job and wage opportunities is not a symptom of immigration but the result of structural changes impacting the UK and other countries throughout the world. Technology and the reduction of human labor in service and manufacturing is ravaging the middle class.
At $2.85 trillion, the United Kingdom is the fifth largest global economy as measured by GDP, sandwiched between Germany and France. Over the past five years, the United Kingdom’s balance of payments, an approximate measure of a country’s exports minus its imports, has grown to a negative $100 billion, indicating that the UK imports roughly $100 billion more of goods and services than it exports. The UK is Germany’s 3rd largest export partner at nearly $100 billion but only ranks 5th for France at $40 billion. This is causing a growing division between Berlin and Paris over how to deal with Britain’s exit from the EU. Germany, whose economic health is more dependent on maintaining strong trade relations with the UK, called for a thoughtful response to “analyze and evaluate the situation calmly” adding “the German government will pay special attention to the interests of German citizens and German business.” France’s response was not as measured. Focused on punitive actions to deter others from following suit, the French are calling for a “quickie divorce” and demanding that the UK immediately invoke article 50 (the article that defines the process for a country to exit the EU) and that negotiations start promptly to hasten Britain’s exit from the EU. Emboldened by the recent populist movement in the United Kingdom, opposition party leaders in Spain, Italy, the Netherlands and even France are beginning to call for their own referendum on EU membership.
Even if article 50 were invoked today, the UK will still have a two-year window to negotiate its departure. A lot can happen in two years. Theresa May, The United Kingdom’s new Prime Minister, and her government will be charged with navigating its exit from the EU, assuming that they vote in favor of upholding the referendum. Of course, all of this is predicated that the European Union will survive over the next two years. With the growing surge in geopolitical discontent, only one thing is for certain: Uncertainty is here to stay.
The financial media likes to remind us that the global economy (negative interest rates and all) is in unchartered territory and markets do not react well to uncertainty. Surprising or uncertain events, like the “Brexit,” will often lead to emotional knee-jerk reactions in the market. This is nothing new. What is different is the magnitude of the short-term impact it is having both on the markets and investors’ psyche.
The concept of certainty is a fleeting illusion at best. Many investors, who had been lulled into a false sense of security by a low-interest rate induced bull market, are waking to the fact that short-term market volatility is erratic and can strike without warning. The “Brexit” caught the world markets flat footed, driving the S&P 500 down by 5% in the two days following the referendum and reducing global equity markets by nearly $3 trillion. However, by Friday, July 1st, a week after the “Brexit” vote, the S&P 500 had almost fully recovered, declining only 0.4% from its close on June 23rd.
So, how does one invest in a market where unanticipated events can evaporate yearly market gains in a matter of days? By embracing the uncertainty and harnessing investors’ fearful overreactions. Successful investors need to focus on their investing strategy, remain vigilant for investing opportunities and not let short-term market vagaries dictate their actions. It is more than likely that the markets will remain volatile for the time being, but investors need to be mindful that not every market decline is a buying opportunity. As mentioned in the past, there are a number of key variables that Hazelton Capital Partners targets before making an investment: A robust balance sheet, strong and sustainable revenue and margins, and thoughtful management incentivized to create value. We are unwilling to change our investing process in reaction to market gyrations. A vetted investing process is key to maintaining the discipline needed during the maelstrom of market distress. As difficult as it may be, the best advice is often to stay calm and embrace the uncertainty.
This article has been excerpted from a letter to partners of Hazelton Capital Partners.