The news of the vote in the United Kingdom (UK) to exit the European Union (EU) shocked markets, but only briefly. The U.S. stock market as measured by the S&P 500 index has reached new highs, albeit on low volume. So what has changed, if anything? There has been a change in leadership in the UK. The new Prime Minister says she will honor the vote although she was personally in favor of remaining in the EU. Nonetheless, Article 50 of the Lisbon Treaty has not been triggered to initiate the process of leaving the EU and may not be exercised this year. For the time being, then, nothing has actually changed. The UK is still a member of the EU. However, the level of anxiety and uncertainty over the future is already having a profound effect within the UK, and it will have a negative impact on global growth.
There were immediate effects of the vote in the UK. The pound sterling fell from 1.51 to the U.S. dollar to under 1.30, a 31year low. Six property funds representing half of the £25 billion sector suspended trading after a rush of redemption requests following the referendum. Office buildings and residential real estate could be down as much as 20%. Uncertainty over the future of London as a financial center and the residency status of 3 million continental Europeans just adds to the confusion. That is not to say that there are not good reasons for the citizens to vote the way they did or that there will not be benefits to leaving the union. However, the lack of a “Plan B” has caught everyone unprepared. Initially, the effect will be to contribute to slowing global growth.
“The vote in the United Kingdom in favor of leaving the European Union adds significant uncertainty to an already fragile global recovery,” the International Monetary Fund said in its latest World Economic Outlook. It went on to say that while the full impact of the vote is hard to quantify right now, “global confidence effects and tighter financial conditions – amid the prolonged negotiations that are likely to precede a new relationship between the United Kingdom and the European Union – could affect global growth negatively beyond what is envisioned in the baseline scenario.”
Already, there are signs that Britain’s economy is shrinking. The flash Markit surveys of purchasing managers give an early indication of how the gross domestic product (GDP) is likely to perform. The Purchasing Managers’ Index (PMI) for the services sector fell in the UK to 47.4 in July from 52.3in June, the steepest drop since records began in 1996 and the worst reading since March 2009. The Manufacturing PMI fell to 49.1 from 52.1 in June, the lowest since February 2013.
The EU receives 53% of the UK’s exports, and the UK receives 49% of its imports from them. The slowing UK economy will undoubtedly affect the rest of the EU. A slowing Europe and a slowing US will put further pressure on China and other Far Eastern trading partners since both Europe and the United States represent large export markets. China, in particular, will face challenges managing its currency as it must balance its desire to lower the value of the yuan for competitive advantage with its desire to be a reserve currency.
This trend of slow economic growth and less global trade will be exacerbated if the UK’s withdrawal from the EU inspires others. A major consideration for the vote was the immigration issue. Ironically, Britain enjoyed more economic growth than elsewhere in the EU, resulting in more jobs particularly for skilled workers. Half of the new jobs have gone to Europeans. The other issue affecting the Brexit vote was the perceived bureaucratic burden imposed by the EU leadership in Brussels. Concerns about the loss of control over borders, aggravated by the flood of refugees from the war torn Middle East, and the lack of sensitivity by EU bureaucrats is not unique to Britain. As violence and sexual assaults increase, there is risk that other member countries will follow the UK’s lead. If the EU leadership does not show more sensitivity to local cultural and business concerns, then the union will indeed fracture.
Slowing economic growth is spurring protectionist policies around the world, even in prosperous countries. The trend is clearly evident in the two major political parties in the U.S. Unfortunately, this dual phenomenon of slowing economic growth and declining global trade will be an integral part of this investment cycle.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided Bloomberg and Gary Schilling.
- Bonds are subject to rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
- High yield/junk bonds (Grade BB or below) are not investment grade securities and are subject to higher interest rate, credit and liquidity risks than those braded BBB and above.
- The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
- Indices are unmanaged and cannot be invested into directly.
- All investing involves risk including loss of principal.