In a stunning defeat for the status quo of the UK, its citizens have voted to leave the European Union. The results of the election came across as a huge surprise to many, despite polls showing a very tight race for the past several weeks. The market run-up in the days preceding the vote, in anticipation of the “remain” forces carrying the day, highlights the failure of financial, political and media pundits to anticipate the mood of the people.
Prime Minister David Cameron tendered his resignation following the vote, not an unexpected move yet still unsettling. Indeed, today’s declines in the world’s largest market indices look a bit frightening on the surface, and foreign exchange markets notched immediate adjustments to this new reality.
With that said, we note the reaction to the “leave” result was entirely consistent with what had been projected in many analysts’ scenario-modeling ahead of the vote. Key central banks are stepping in to try to calm markets, already signaling potential future actions. Moreover, the global sell-off witnessed today was not as significant as the headlines might make them appear. The S&P 500, for example, closed the day today at 2037, a level last seen on March 28th. The index is now nearly exactly flat for the year, having closed 2015 at 2043.
There is no doubt that in the short run at least, this is not good news for the markets. It will take years for England and Europe to manage the logistics of the exit, and the resultant changes in policy and practice will in turn have implications for corporate strategies. Taken together these challenges will add new complexity to what was already a highly uncertain investment environment.
We anticipate slower global growth in the developed world as well as in emerging markets for the foreseeable future, along with heightened risk aversion and greater risks of deflation. Considering the slow-growth scenario we’ve already experienced for the better part of a decade, this is not a positive for employment, corporate earnings, equity valuations or returns.
The silver lining here is that interest rates are now likely to remain lower for a more extended period of time, which should eventually stimulate consumer spending and broader economic growth.
We do not anticipate a recession on the horizon in the United States based on these developments, though we do expect some short-term ramifications to the US economy. For example, we expect the dollar to regain its upward momentum even with the Fed likely on hold for the foreseeable future, which will be a negative for US multinational corporate earnings and commodities in particular.
Our tactical asset allocation is under review. However, our investment approach remains focused on the long term. And while there are new risks to the long-term picture given the potential for contagion to other European countries (whether economic or political), the impending US presidential election, and to a new slightly slower global economic environment, we do not view these risks as systemic, nor as existential to the global economy.
In sum, for long-term investors we expect this news to be incorporated into the set of broader challenges the world has already been facing, without drastic overall effects.
Phil Kirshman, CFA, CFP®, Chief Investment Officer, Cornerstone Capital Investment Management
Michael Geraghty, Global Equity Strategist, Cornerstone Capital Group Research