Brexit UpdateSubmitted by LongView Asset Management LLC on June 24th, 2016
June 24, 2016 – Given the unexpected outcome of the Brexit vote last night, we thought you might appreciate a summary of what we are thinking and hearing from economists and portfolio managers. There appears to be consensus that the impact of Brexit will be significant but manageable.
JP Morgan Chief Economist David Kelly characterized it as “a big problem for a small country.” But he reminded listeners on a call this morning that the UK represents less than 4% of global GDP. Britain will not disappear nor will trade with Britain evaporate. Brexit has caused a local shock but doesn’t put the global recovery at risk.
Most observers agree that the consequences of Brexit for the UK are serious. Fidelity estimates that loss of business confidence could shave as much as 1% from UK growth. A weaker pound will push inflation higher. The chance of a UK recession is now significantly greater than before the vote.
Brexit will also affect the Continent, though less severely. The already sluggish EU economy will slow further but is unlikely to fall into recession. The ECB will provide aggressive monetary stimulus. Consumer spending is strengthening and unemployment declining. The European economic climate is not dynamic, but as JP Morgan chief economist David Kelly remarked: “It’s hard to injure yourself jumping out of a basement window.” From current sub-par levels, there is less room to fall.
Brexit is unlikely to have a material impact on the US economy. There is no evidence of weakening in economic data. US durable goods, PMI, housing and capital spending suggest rebounding growth in the second quarter. Should the dollar strengthen and oil prices fall further, US corporate profits will be squeezed, but the headwind to earnings should still be less severe than in 2015. Consumer spending, which represents 70% of our economy, will be helped as purchasing power gains from a strong dollar and low fuel costs. The Fed, moreover is likely to put further interest rate hikes on hold. All signs suggest that our late cycle recovery could actually be extended by current events and that the domestic economy will continue to grow.
Financial markets have so far been orderly in their decline. Liquidity has been adequate. Central banks are providing support. In contrast to the 2008 financial crisis, bank balance sheets and capital levels are healthy and there is little concern about the functioning of the banking system.
The longer-term ramifications of Brexit are troubling. Referendums on EU membership may be called in other countries. A spreading wave of populism, protectionism and anti-globalization could compromise the robustness of the world economy. Free-flowing trade is the lifeblood of healthy growth with low inflation. Fidelity’s economists describe de-globalization as a “negative one-way street.”
At LongView we built cash up to roughly 10% of our firm-wide holdings earlier this year. This cash is helping to cushion our portfolios from the current turbulence. We expect volatility to remain elevated in the coming weeks while markets digest the Brexit vote. As always, we are weighing both the opportunities and risks as events unfold. Please don’t hesitate to call us with any questions or concerns. We are here at your service.
David, Harlan and Mariah