#152 Brexit

Darcy was watching a pirate show on the weekend, and one of the
characters commented that when you’re in a room full of still air just waiting for the dust to settle, sometimes you forget the dust is an unnatural state, itself only just waiting for the winds of change.

The United Kingdom (UK) is in a cloud of dust after a referendum
vote to leave the European Union (EU), a term known as Brexit (the love child of Britain and Exit). The votes were cast and the referendum is complete, but the winds on which the United Kingdom will be re-sovereignized is still just a draft from a jarred door.

The concept of an exit from the EU has never been tried before, and for that reason it’s interesting to watch. It was also unexpected, so for that reason it’s making the news. But these things together are tied with a poor quality of information. Nobody knows what is going to happen, because it’s never been done before.

For now, the UK is still a member of the EU. A referendum has no
power of process, it’s just a survey amongst the voting members of a group. To the UK’s credit, they had a very high voter turnout rate, at about 72%, which shows significant passion towards the issue. But the vote was also split down the middle, with only the slightest preference to a Brexit. This means that still about half of UK citizens would prefer to Remain.

And this is something that the House of Commons will be taking
into account in the coming months. Whatever decision is
made now, will have lasting effects in the coming decade. The
first step, from a logistics point of view, is for the MPs to vote on the enactment of Article 50 of the Lisbon Treaty, which would officially start the process of a Brexit. Now that the British Prime Minister will be resigning, this vote will likely be delayed until a new leader of the party is elected in
October. And even then, the House could bring about a vote of
non-confidence, triggering an election, and further complicating
or extending the Brexit process.

The next step is a two year negotiation period that works
through the terms of the Brexit. In order for this agreement to be approved, all of the remaining 27 member countries of the EU and Britain must be unanimously in favor with majority parliamentary votes. There is likely to be significant challenges to this, both from the political side, and the
logistics side.

From the political side, the remaining scorned major players in the EU are looking to make an example of Brexit; to bring some of the far-right political change drivers back into the playing field of reality, and show the member nations that a vote to leave the EU is a vote for recession.

From a logistics point of view, the trade treaties that need to be reviewed and amended are an estimated 80,000 pages long.
Previous favorable conditions are already off the table, and the
conditions the UK is asking for have been suggested as guaranteed non-starters. Reading at an average of one page per
minute, with a five minute tea break every half hour, just reading these documents alone would take 400 days.

So looking at all of the short-term media attention and long-term political implications, what is the impact on a Canadian investment portfolio?

We all know that the first logical step in understanding something new is to over-react with wildly convicted and unfounded views of fear and uncertainty, and so it’s
comforting to see that this process has already begun. After most of the world was betting on the Remain camp, global markets plummeted after the initial results of the referendum.

The second step is to understand that these challenges are real, and even though they’re kind of new and interesting, they’re also proactive. The government stimulus packages and new
legislation following the credit crisis of 2008 were scary because they were reactionary. Governments were using water to
douse an oil fire. The Brexit referendum is different because it’s the foreshadowing of a possible future change, one that
will likely take the greater part of a decade to finalize. These changes will be controlled and adapted to along the way, like lowing the heat whenever the oil starts smoking. It needs to be this way. On a comparative scale of exports, Britain is only worth about 3% to the EU, but the EU is worth about 13% to Britain. The UK needs the process to be orderly, or they risk significant unnecessary self inflicted pain.

From a shorter term perspective on the financial markets, we will see changes, but mostly in the areas of currency and counter market investments such as gold, as investors seek out a bit of stability against any unfolding drama. Comparing the Pound to the US Dollar, and we’re already at a 30 year low.

From a longer-term perspective a Brexit would likely cause the UK to lose its identity as a bustling global hub. Remember that half of the members of the EU wanted to Remain, and the pre-referendum poles suggested that this included the majority of young university educated professionals. This could potentially lead to issues where Britain has to fight emigration of the educated, which leads to lower longer-term GDP. There will
also likely be a drag on the markets both from the loss of
globalization (higher tariffs results in hampered trade) and from the reduction of immigration (immigrants, on average, add to GDP as people are suddenly exposed to an environment where
their determination can build a better life for their families. And determined they are).

In the meantime, there are certain to be investment opportunities. It wouldn’t be surprising to see the Pound devalue further in the coming year, and the volatile reactions as the Brexit unravels is likely to add to volatility for
months. Overall, however, this probably isn’t going to be one of
those obvious earth-shattering opportunity clusters, although that depends on a good extent to how frightened people become, and what ripple-effects Brexit has with other outlying European member nations.

In the end, a Brexit will mean that Britain is slightly less involved as a trading partner with the rest of the world, and there could be opportunities for investors who can withstand heightened volatility. Fund managers are likely to become buyers in the coming days, but our target allocations aren’t going to be affected. The best moves here could be to still
just sit and patiently wait for the dust to settle.

If you have any questions on how the global political landscape
could affect your financial goals, or for more information on building in portfolio counter-balances for reduced volatility, speak with a Certified Financial Planner today.

Written by Meagan S. Balaneski, CFP, R.F.P.

Meagan S. Balaneski, CFP, R.F.P CERTIFIED FINANCIAL PLANNER® Advantage Insurance & Investment Advisors Investment Funds Representative Manulife Securities Investment Services Inc.

The opinions expressed are those of Meagan S. Balaneski and may not necessarily reflect the views of Manulife Securities Investment Services Inc.

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