What is a Brexit?

Imagine you started a business with several different partners. Over the years, your business had its ups and downs, its fits and starts, its soaring successes and frustrating failures. During that time, you became more and more tied to your business, and your partners became more than just colleagues. They became people you invested in, and who invested in you. Occasionally, they were also people who you argued with and who argued with you. Sometimes, you didn’t know what you’d do without them. Other times, you wondered why you ever partnered up with them in the first place.

Now imagine a day when someone in your family says, “Why are you still with them? Wouldn’t you be better off going solo? Then you wouldn’t have to deal with all the things that frustrate you.”

Sounds reasonable, you think, until another family member says, “No, you should stay. You never would have come this far without your partners. You are stronger together than you are apart. Remember, a chain is made of many links, not just one.”

What do you do? The answer to this question is exactly what the United Kingdom has to decide.

You see, the scenario I just described is similar to the much-debated “Brexit.” What is Brexit? It’s a portmanteau of the words “British” and “exit,” and it refers to the upcoming referendum on whether the United Kingdom should remain in the European Union or not. The results of this referendum will have enormous implications for the entire European continent ... and the global markets.

Recently, several of my clients have asked about whether Brexit is something they should keep an eye on. So this letter is my way of explaining exactly what’s going on, and what it means for us here on the other side of the Atlantic.

Let’s start off by talking about what, exactly, Brexit is.

An (Extremely) Brief History of the UK and the European Union

The EU is both an economic and political union of 28 different European nations. Most of the member states share a common currency, and they work in concert to enact laws and regulations that ensure the free movement of people, goods, and services.

The origins of the EU trace back to the post-World War II days when several countries in Western Europe decided to link themselves more closely together so they could prevent another disastrous conflict. Since then, the EU has grown and grown. The United Kingdom joined in 1973, but from the start, it’s been a shaky marriage. Only two years after joining, the UK held a vote to decide whether staying in the EU was a good idea. The majority of voters decided to remain on that particular occasion, but it signaled the start of what would become a decades-long debate.

Fast forward to 2015. During the UK’s general election, British Prime Minister David Cameron gave voters a promise: if reelected, he would see to it that another vote would be held to settle the issue. Cameron was reelected, and, true to his word, scheduled the referendum for June 23, 2016.

Why Do People in the UK Want a Referendum at All?

Let’s go back to the analogy we started with. Imagine a family member says your partners are limiting your right to make decisions based on what’s best for you. They point out that you now have even more partners than when you started, giving you less of a voice in how to run the business.

That’s essentially the argument many “Leavers” are making. Others claim that leaving the EU would help stop what they see as an unwanted influx of immigrants by giving the UK more control of their own borders.

On the other side, there are many people who want to stay in the European Union. Choosing otherwise, they believe, would result in millions of jobs being lost. They also see immigration as good for the economy, and claim the UK enjoys more influence inside the EU than out.

At this point, which side will prevail is anybody’s guess. Public opinion polling has consistently shown an almost equal split between the two. But should the United Kingdom choose to leave the European Union, one thing is certain: there will be consequences.

Why a Possible Brexit Could Affect the Markets

When a butterfly flaps its wings in Brazil, a tornado forms in Texas. (Or at least that’s how the saying goes.) Thanks to modern technology, the four corners of the world are closer than ever. Even the mighty Atlantic Ocean becomes a mere pond where the markets are concerned. That’s why the ripples near one shore are often felt on the other.

Brexit could have an enormous impact on the UK’s economy. Many economists believe that leaving would decrease economic growth, weaken Britain’s currency, raise the cost of imports, and even diminish London’s standing as a global financial center. Should any of these things happen, the UK’s financial health could suffer, at least in the short term. One study even suggests that British stocks “could lose up to a quarter of their value.”1

If that happens, the ripples that start near the banks of the River Thames could extend outward. There are many companies in the U.S. that have made investments in the United Kingdom. In 2014 alone, U.S. companies invested a total of $588 billion into Britain.2 These companies could be financially affected if the British stock market suffers.

Even more significant is that Britain’s exit will mean the departure of over $100 billion in securities from European banks.2 And should certain members of the European Union continue to experience economic hardship, they will have to deal with it without the UK’s help. And as we’ve learned over the last half-decade, volatility in the EU means volatility around the world.

Ultimately, however, the biggest impact Brexit will have can be summed up in a single word: Uncertainty.

To put it simply, the markets hate uncertainty. The simple matter of not knowing what will happen is enough to make even the hardiest investors jittery. Uncertainty has been the culprit behind many periods of market volatility. With Brexit, there are so many unknowns, so many variables, so many maybes and mights. The fact of the matter is that nobody knows what the UK will do, or what the consequences will be. And that uncertainty has some investors nervous.

SO WHAT SHOULD WE DO?

First is to keep a close eye on the situation. In particular, my team and I will be monitoring your portfolio for any exposure to the United Kingdom or the European Union. If we feel any changes are warranted, we will let you know immediately.

The second and most important thing to do is not overreact. To be blunt, overreacting to uncertainty is one of the worst things we could do. So whatever happens on June 23, we will not overreact. Whatever uncertainty we may feel, we will not overreact. Instead, we will be careful, watchful, unemotional, and analytical. We will stick to our strategy and focus on our long-term goals above all else.

There are two good reasons for this. First is that it’s simple common sense. Second is that even if the UK votes to leave the EU, actual change will be a long time coming. This referendum is simply to decide whether to start the process. There will be months, maybe even years of negotiations between June 23 and a complete split. So while the implications of Brexit are significant, they will also take some time to develop.

What should you do in the meantime, «Salutation»? Simple: enjoy your summer! My team and I will hold down the fort and keep a close eye on the markets. We will contact you if there’s anything else you need to know.

I hope you found this letter informative. If you have any questions about Brexit, the markets, or anything else, please don’t hesitate to contact us. We are always happy to hear from you, and our door is always open!