The citizens of the UK voted yesterday in a referendum to leave the European Union, or “Brexit.” This result was a surprise to most pollsters and market participants.
Here are 7 Thoughts True North Advisors has on Brexit:
1. While this vote is non-binding, it is unlikely that the members of the UK Parliament would not respect the wishes of the majority.
2. In some senses, the vote is the manifestation of the dissatisfaction of the masses vs. the elites who are perceived to have influenced the system for their gain, a sentiment that is also shared in the USA.
3. Markets, understandably, are down meaningfully with the S&P 500 being down almost 2.5% and the 10 year US treasury yield down almost 17 bps to 1.58%.
4. While we have no ability to predict such outcomes, we do know that expensive markets do not reward investors over the long term. Consequently, we reduced equity exposure in client accounts in May on account of our valuation concerns.
5. Additionally, we started to build a small position in gold miners on the basis of their cheap valuations, and asymmetric risk-reward characteristics. Gold miners are up 6% today.
6. While the near term reaction of the markets has been predictable, we are uncertain of the medium term impact. The central banks will almost undoubtedly take policy actions to support the markets and add liquidity which could boost markets, and we believe that the odds of another rate hike by the Fed are now almost non-existent.
7. On the other hand, the interlinked and highly levered global financial system is vulnerable to an unexpected shock, and unpredictable outcomes are possible. For example, the weak British pound may lead to a global currency war, and a potential Chinese devaluation, which may create even more uncertainly.
Bottom line: Ultimately, we harken back to our reliance on valuations as a reliable guidepost of long term returns. Valuations continue to be unfavorable in our view, and our positioning will continue to be conservative till such time valuations improve. While we were proactive in reducing portfolio risk in May, we continue to remain vigilant towards additional unanticipated risks and will be opportunistic in deploying capital.