Posts tagged ‘brexit’

Head Fakes Surprise as Stocks Hit Highs

In a world of seven billion people and over 200 countries, guess what…there are a plethora of crises, masses of bad people, and plenty of lurking issues to lose sleep over.

The fear du jour may change, but as the late-great investor Sir John Templeton correctly stated:

“Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.”

 

And for the last decade since the 2008-2009 Financial Crisis, it’s clear to me that the stock market has climbed a lot of worry, pessimism, and skepticism. Over the last decade, here is a small sampling of wories:

With over five billion cell phones spanning the globe, fear-inspiring news headlines travel from one end of the world to the other in a blink of an eye. Fortunately for investors, the endless laundry list of crises and concerns has not broken this significant, multi-year bull market. In fact, stock prices have more than tripled since early 2009. As famed hedge fund manager Leon Cooperman noted:

“Bull markets don’t die from old age, they die from excesses.”

 

On the contrary to excesses, corporations have been slow to hire and invest due to heightened risk aversion induced by the financial crisis. Consumers have saved more and lowered personal debt levels. The Federal Reserve took unprecedented measures to stimulate the economy, but these efforts have since been reversed. The Fed has even signaled its plan to reduce its balance sheet later this year. As the expansion has aged, corporations and consumer risk aversion has abated, but evidence of excesses remains paltry.

Investors may no longer be panicked, but they remain skeptical. With each subsequent new stock market high, screams of a market top and impending recession blanket headlines. As I pointed out in my March Madness article, stocks have made new highs every year for the last five years, but continually I get asked, “Wade, don’t you think the market is overheated and it’s time to sell?”

For years, I have documented the lack of stock buying evidenced by the continued weak fund flow sales. If I could summarize investor behavior in one picture, it would look something like this:

Corrections have happened, and will continue to occur, but a more significant decline will likely happen under specific circumstances. As I point out in Half Empty, Half Full?, the time to become more cautious will be when we see a combination of the following trends occur:

  • Sharp increase in interest rates
  • Signs of a significant decline in corporate profits
  • Indications of an economic recession (e.g., an inverted yield curve)
  • Spike in stock prices to a point where valuation (prices) are at extreme levels and skeptical investor sentiment becomes euphoric

Attempting to predict a market crash is a Fool’s Errand, but more important for investors is periodically reviewing your liquidity needs, time horizon, risk tolerance, and unique circumstances, so you can optimize your asset allocation. There will be plenty more head fake surprises, but if conditions remain the same, investors should not be surprised by new stock highs.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

June 10, 2017 at 2:33 pm 2 comments

Managing the Chaos – Investing vs. Gambling

How does one invest amid the slew of palm sweating, teeth grinding headlines of Syria, North Korea, Brexit, expanding populism, Trumpcare, French candidate Marine Le Pen, and a potential government shutdown? Facing a persistent mountain of worries can seem daunting to many. With so many seemingly uncontrollable factors impacting short-term interest rates, foreign exchange rates, and equity markets, it begs the question of whether investing is a game of luck (gambling) or a game of skill?

The short answer is…it depends. Professional gambler Alvin “Titanic” Thompson captured the essence when someone asked him whether poker was a game of chance. Thompson responded by stating, “Not the way I play it.”

If you go to Las Vegas and gamble, most games are generally a zero sum-game, meaning there are an equal number of winners and losers with the house (casino) locking in a guaranteed spread (profit). For example, consider a game like roulette – there are 18 red slots, 18 black slots, and 2 green slots (0 & 00), so if you are betting on red vs. black, then the casino has a 5.26% advantage. If you bet long enough, the casino will get all your money – there’s a reason Lost Wages Las Vegas can build those extravagantly large casinos.

The same principles of money-losing bets apply to speculative short-term trading. Sure, there are examples of speculators hitting it big in the short-run, but most day traders lose money (see Day Trading Your House) because the odds are stacked against them. In order to make an accretive, profitable trade, not only does the trader have to be right on the security they’re selling (i.e. that security must underperform in the future), but they also have to be right on the security they are buying (i.e. that security must outperform in the future). But the odds for the speculator get worse once you also account for the trading fees, taxes, bid-ask spreads, impact costs (i.e., liquidity), and informational costs (i.e., front running, high frequency traders, algorithms, etc.).

The key to winning at investing is to have an edge, and the easiest way to have an investing edge is to invest for the long-run – renowned Professor Jeremy Siegel agrees (see Stocks for the Long Run). It’s common knowledge the stock market is up about two-thirds of the time, meaning the odds and wind are behind the backs of long-term investors. Short-term trading is the equivalent of going fishing, and then continually pulling your fishing line out of the water (you’re never going to catch anything). The fisherman is better off by researching a good location and then maintaining the lure in the water for a longer period until success is achieved.

Although most casino games are based on pure luck, there are some games of skill, like poker, that can produce consistent long-term positive results, if you are a patient professional with an advantage or edge (see Dan Harrington article ).  Having an edge in investing is crucial, but an edge is not the only aspect of successful investing. How you structure a portfolio to control risk (i.e., money management), and reducing your personal behavioral biases are additional components to a winning investment strategy. Professional poker player Walter Clyde “Puggy” Pearson summed it up best when he described the three critical components to winning:

“Knowing the 60-40 end of a proposition, money management, and knowing yourself.”

 

At Sidoxia Capital Management, we have also achieved long-term success by following a systematic, disciplined process. A large portion of our investment strategy is focused on identifying market leading franchises with a long runway of growth, and combining those dynamics with positions trading at attractive or fair values. As part of this process, we rank our stocks based on multiple factors, primarily using data from our proprietary SHGR ranking (see Investing Holy Grail) and free cash flow yield analysis, among other important considerations. Based on the risk-reward profiles of our existing holdings and the pool of targeted investments, we can appropriately size our positions accordingly (i.e., money management). As valuations rise, or risk profiles deteriorate, we can make the corresponding portfolio positions cuts, especially if we find more attractive alternative investments. Having a proven, systematic, unbiased process has helped us tremendously in minimizing behavioral pitfalls (i.e., knowing yourself) when we construct client portfolios.

The world is under assault…but that has always been the case. Throughout investment history, there have been wars, assassinations, unexpected election outcomes, banking crises, currency crises, natural disasters, health epidemics, and more. Unfortunately, millions have gambled and bet their money away based on these frivolous, ever-changing, short-term headlines. On the other hand, those investors who understand the 60-40 end of a proposition, coupled with the importance of money management and controlling personal biases, will be the skillful winners to prosper over the long-run.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 23, 2017 at 10:53 am Leave a comment

Double Dip Expansion?

Ever since the 2008-2009 financial crisis, every time the stock market has experienced a -5%, -10%, or -15% correction, industry pundits and media talking heads have repeatedly sounded the “Double Dip Recession” alarm bells. As you know, we have yet to experience a technical recession (two reported quarters of negative GDP growth), and stock prices have almost quadrupled from a 2009 low on the S&P 500 of 666 to 2,378 today (up approximately +257%).

Over the last nine years, so-called experts have been warning of an imminent stock market collapse from the likes of PIIGS (Portugal/Italy/Ireland/Greece/Spain), Cyprus, China, Fed interest rate hikes, Brexit, ISIS, U.S. elections, North Korea, French elections, and other fears. While there have been plenty of “Double Dip Recession” references, what you have not heard are calls for a “Double Dip Expansion.”

Is it possible that after the initial 2010-2014 economic expansionary rebound, and subsequent 2015-2016 earnings recession caused by sluggish global growth and a spike in the value of the U.S. dollar, we could possibly be in the midst of a “Double Dip Expansion?” (see earnings chart below)

Source: FactSet

Whether you agree or disagree with the new political administration’s politics, the economy was already on the comeback trail before the November 2016 elections, and the momentum appears to be continuing. Not only has the pace of job growth been fairly consistent (+235,000 new jobs in February, 4.7% unemployment rate), but industrial production has been picking up globally, along with a key global trade index that accelerated to 4-5% growth in the back half of 2016 (see chart below).

Source: Calafia Beach Pundit

This continued, or improved, economic growth has arisen despite the lack of legislation from the new U.S. administration. Optimists hope for an improved healthcare system, income tax reform, foreign profit repatriation, and infrastructure spending as some of the initiatives to drive financial markets higher.

Pessimists, on the other hand, believe all these proposed initiatives will fail, and cause financial markets to fall into a tailspin. Regardless, at least for the period following the elections, investors and companies have perceived the pro-business rhetoric, executive orders, and regulatory relief proposals as positive developments. It’s widely understood that small businesses supply the largest portion of our nation’s jobs, and the upward spike in Small Business Optimism early in 2017 is a welcome sign (see chart below).

Source: Calafia Beach Pundit

Yes, it is true our new president could send out a rogue tweet; start a trade war due to a tariff slapped on a critical trading partner; or make a hawkish military remark that isolates our country from an ally. These events, along with other potential failed campaign promises, are all possibilities that could pause the trajectory of the current bull market. However, more importantly, as long as corporate profits, the mother’s milk of stock price appreciation, continue to march higher, then the stock market fun can continue. If that’s the case, there will likely be less talk of “Double Dip Recessions,” and more discussions of a “Double Dip Expansion.”

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

March 19, 2017 at 12:34 pm Leave a comment

Huh… Stocks Reach a Record High?

confused

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (September 1, 2016). Subscribe on the right side of the page for the complete text.

The stock market hit all-time record highs again in August, but despite the +6.2% move in 2016 S&P 500 stock prices (and +225% since early 2009), investors continue to scratch their heads in confusion. Individuals continue to ask, “Huh, how can stocks be trading at or near record levels (+6% for the year) when Brexit remains a looming overhang, uncertainty surrounds the U.S. presidential election, global terrorist attacks are on the rise, negative interest rates are ruling the day, and central banks around the globe are artificially propping up financial markets (see also Fed Myths vs. Reality)? Does this laundry list of concerns stress you out? If you said “yes”, you are not alone.

As I’ve pointed out in the past, we live in a different world today. In the olden days, terrorist attacks, natural disasters, currency crises, car chases, bank failures, celebrity DUIs, and wars happened all the time. However, before the internet existed, people either never heard about these worries, or they just didn’t care (or both). Today, we live in a Twitter, Facebook, Instagram, Snapchat, society with 500+ cable channels, and supercomputers in the palm of our hands (i.e., smartphones) with more computing power than existed on the Apollo mission to the moon. In short, doom-and-gloom captures human attention and sells advertising, the status quo does not.

In the same vein, here’s what doesn’t sell or capture much attention:
  • Record corporate profits are on the rise
  • Stabilizing value of the dollar
  • Stabilizing energy and commodity prices
  • Record low interest rates
  • Skeptical investing public

Fortunately, the stock market pays more attention to these important dynamics, rather than the F.U.D. (Fear, Uncertainty, Doubt) peddled by the pundits, bloggers, and TV talking heads. Certainly, any or all of the previously mentioned positive factors could change or deteriorate over time, but for the time being, the bulls are winning.

Let’s take a closer look at the influencing components that are driving stock prices higher:

Record Corporate Profits

Source: Yardeni.com

Profits are the mother’s milk that feeds the stock market. During recessions, profits are starved and stock prices decline. On the flip side, economic expansions feed profits and cause share prices to rise. As you can see from the chart above, there was a meteoric rise in corporate income from 2009 – 2014 before a leveling off occurred from 2015 going into 2016. The major headwinds causing profits to flatten was a spike of 25% in the value of the U.S. dollar relative to the value of other global currencies, all within a relatively short time span of about nine months (see chart below).

Why is this large currency shift important? The answer is that approximately 40% of multinational profits derived by S&P 500 companies come from international markets. Therefore, when the value of the dollar rose 25%, the cost to purchase U.S. products and services by foreign buyers became 25% costlier. Selling dramatically higher cost goods abroad squeezed exports, which in turn led to a flattening of profits. Time will tell, but as I showed in the first chart, the slope of the profit line has resumed its upwards trajectory, which helps explain why stock prices have been advancing in recent months.

Besides a strong dollar, another negative factor that temporarily weakened earnings was the dramatic decline in oil prices (see chart below) Two years ago, WTI oil prices were above $100 per barrel. Today, prices are hovering around $45 per barrel. As you can imagine, this tremendous price decline has had a destructive impact on the profits of the energy sector in general. The good news is that after watching prices plummet below $30 earlier this year, prices have since stabilized at higher levels. In other words, the profits headwind has been neutralized, and if global economic growth recovers further, the energy headwind could turn into an energy tailwind.

Record Low Interest Rates

Stocks were not popular during the early 1980s. In fact, the Dow Jones Industrial Average traded at 2,600 in 1980 vs 18,400 today. The economy was much smaller back then, but another significant overhang to lower stock prices was higher interest rates (and inflation). Back in 1980, the Federal Funds target rate set by the Federal Reserve reached a whopping 20.0% versus today the same rate sits at < 0.5%.

Why is this data important? When you can earn a 16.99% yield in a one-year bank CD (see advertisement below), generally there is a much smaller appetite to invest in riskier, more volatile stocks. Another way to think about rates is to equate interest rates to the cost of owning stocks. When interest rates were high, the relative cost to own stocks was also high, so many investors liquidated stocks. It makes perfect sense that stocks in that high interest rate environment of 1980 would be a lot less attractive compared to a relatively safe CD that paid 17% over a 12-month period.

On the other hand, when interest rates are low, the relative cost of owning stocks is low, so it makes sense that stock prices are rising in this environment. Just like profits, interest rates are not static, and they too can change rapidly. But as long as rates remain near record lows, and profits remain healthy, stocks should remain an appealing asset class, especially given the scarcity of strong alternatives.

Skeptical Investing Public

The last piece of the puzzle to examine in order to help explain the head-scratching record stock prices is the pervasive skepticism present in the current stock market. How can Brexit, presidential election, terrorism, negative interest rates, and uncertain Federal Reserve policies be good for stock prices? Investing in many respects can be like navigating through traffic. When everyone wants to drive on the freeway, it becomes congested and a bad option, therefore taking side-streets or detours is a better strategy. The same principle applies to the stock market. When everyone wants to invest in the stock market (like during the late 1990s) or buy housing (mid-2000s), prices are usually too inflated, and shrewd investors decide to choose a different route by selling.

The same holds true in reverse. When nobody is interested in investing (see also, 18-year low in stock ownership and two trillion of stocks sold), then generally that is a strong sign that it is a good time to buy. Currently, skepticism is plentiful, for all the reasons cited above, which is a healthy investment indicator. Many individuals continue reading the ominous headlines and scratching their heads in confusion over today’s record stock prices.  In contrast, at Sidoxia, we have opportunistically benefited from investors’ skepticism by discovering plenty of attractive opportunities for our clients. There’s no confusion about that.

investment-questions-border

Wade W. Slome, CFA, CFP®

www.Sidoxia.com

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and FB, but at the time of publishing had no direct position in TWTR or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

September 3, 2016 at 10:52 am Leave a comment

Brexit-Schmexit

British Flag FreeImage1

Do you remember the panic-inducing headlines related to PIIGS, Crimea, Ebola, Cyprus, and the Flash Crash? Probably not. But if you do remember, these false alarms have likely been relegated to the financial memory graveyard, along with the many other sensationalist news events that have been killed off in the post-financial crisis era. Time will tell whether Brexit dies off or becomes a resurrected concern, like the repeating fears of a China slowdown or Greek collapse. Regardless, as the S&P 500 stock index reaches new all-time record highs, investors are currently shrug off the noise while muttering, “Brexit-Schmexit.”

Individuals have tried to use scary headlines as a timing tool to consistently time market corrections for all of recorded history. Unfortunately, emotional, knee-jerk reactions to alarming news stories rarely is the best strategy. Famed fund manager Peter Lynch said it best when he noted,

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

 

Having invested for some 25 years, experience has taught me not only is conventional wisdom often wrong, but it also is frequently an accurate contrarian indicator. In other words, frightening news often should be an indicator to buy…not sell. Case in point is the U.K. European Union referendum. The Brexit referendum “Leave” vote caught virtually everyone by surprise, but the rebound in stock prices to new record highs may be even more surprising to most observers. However, for investors following the key factors of interest rates, profits, valuation, and sentiment (see also Don’t Be a Fool, Follow the Stool), may not be shocked by the positive price action.

  • Interest Rates: For starters, you don’t have to be a genius to realize that stocks become more attractive when there is a scarcity of investment alternatives. When there are an estimated $13 trillion of negative interest rate bonds, a layman can quickly understand a 2%, 3%, or 4% dividend yield offered on certain stocks (and funds) can represent a much more attractive opportunity. With interest rates at record lows (see chart below), the overall dividend yield of stocks has provided a floor for stock prices and has limited the depth and duration of sell-offs and corrections.
Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

  • Profits: Corporate profits are near record highs but have been sluggish due to several factors, including the negative impact of the strong dollar on multinational exports; the depressing effect of declining interest rates on the banking sector’s net interest profit margins; the general decline in oil and commodity prices; and general lethargic economic growth overall in international markets (emerging and developed economies). Encouragingly, a stabilization in the value of the U.S. dollar, along with a rebound in energy prices augurs well for a potential shift back to earnings growth in the coming quarters.
  • Valuation: On a valuation basis, the Price/Earnings ratio of the stock market is about 10-15% above historical averages (see chart below). The average S&P 500 stock price trades around 19x’s the value of trailing twelve-month earnings. However, in the context of all-time record low-interest rates, a premium valuation is well deserved, especially for those companies paying a dividend and growing their bottom line.
Source: Calafia Beach Pundit

Source: Calafia Beach Pundit

  • Sentiment: Since the Great Financial Crisis / Recession, there has been about $1.5 trillion in equity investments that have been pulled out of U.S. equity mutual funds. This statistic is a clear sign of the extreme risk aversion and pervasive pessimism. Despite money flowing out of equity funds, corporations have bolstered the upward trajectory in stock prices with hundreds of billions in corporate stock buybacks and trillions in mergers & acquisition transactions. With all the universal jitteriness, I like to remind investors of Warren Buffett’s credo, “Buy fear, and sell greed.”

Brexit-Schmexit NOT Brexit-Panic

Despite the risk aversion in the marketplace, stock prices in the U.S. continue to grind higher to record levels. The stock market is currently communicating interest rates, profits, valuation, and sentiment are more important factors to price direction than are Brexit and other geopolitical concerns.

The silver lining behind severe investor skepticism is the creation of additional investment opportunities. As famous investor Sir John Templeton stated regarding stock market cycles, “Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.” Even the most objective observers have difficulty pointing to a broad set of indicators signaling euphoria, and the recent Turkish military coup attempt and domestic gun violence incidents will not squash out the negativity. Until optimism and elation rule the day, there’s no need to worry-schworry.

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds , but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

July 17, 2016 at 9:54 pm Leave a comment

EU Marriage Ends in Messy Brexit Divorce

divorce

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 1, 2016). Subscribe on the right side of the page for the complete text.

What Just Happened?

Breakups are never easy, especially when they come as a surprise. That’s exactly what happened with last week’s “Brexit” (British exit) referendum results. History was made when 51.9% of the United Kingdom (U.K.) voters from England, Scotland, Wales and Northern Ireland cast their vote to divorce (“Leave”) their country from the European Union (EU). In the end, the 48.1% of U.K. voters could not generate enough support to “Remain” in the EU (see chart below). Despite torrential downpours in southern Britain, voter turnout was extraordinarily high, as 72% of the 46.5 million registered voters came out in full force to have their voices heard.

Divorce is never cheap, and UK Prime Minister David Cameron paid the ultimate price with his defeat in the Brexit referendum…the loss of his job. Immediately following the release of the referendum results, Cameron, the British Prime Minister since 2010 and leader of the Conservative Party, immediately announced his resignation, effective no later than October 2016 after the selection of his successor.

brexit votes

Source: Bloomberg

One of the reasons behind the shock of the Brexit Leave decision is the longstanding relationship the U.K. has had with the EU. European Union membership first began in 1957 with Belgium, France, Germany, Italy, Luxembourg, and Netherlands being the founding countries of this new political-economic union.

A few decades later, the U.K. officially joined the EU in 1973 with Ireland and the Denmark, shortly before Margaret Thatcher came into power. If you fast forward to today, some 43 years after U.K. originally joined the EU, the Brexit decision represents the largest turning point in European political history. Not since the 1989 falling of the Berlin Wall and the subsequent demise of the Cold War in the Soviet Union has such a large, earth-moving political shift occurred.

Today, there are 28 member countries in the EU with Croatia being the newest member in 2013. Despite the Brexit outcome, there still is a backlog of countries wanting to join the EU club, including Turkey, Serbia, Albania, and Montenegro (and this excludes Scotland, which has voiced an interest in leaving the U.K. for the EU).

What Were Investors’ Reactions?

Financial markets around the world were caught off guard, given many pre-referendum polls were showing the Remain camp with a slight edge, along with British betting parlors that were handicapping an overwhelming victory for the Remain camp. Here’s a summary of stock market reactions around the globe from June 23rd to June 30th:

U.S. (S&P 500): -0.7%

U.K. (FTSE 100): +2.6%

Japan (Nikkei): -4.1%

Germany (DAX): -5.6%

Hong Kong (Hang Seng): +0.4%

China (Shanghai): +1.3%

India (BSE): -0.0%

Surprisingly, modest monthly gains achieved in the S&P 500 prior to the Brexit vote (up +0.8%) were quickly pared after the results came in but remained positive for the entire month (up +0.1%). For the year, U.S. stocks are up a limited +2.7%, which isn’t too bad considering investors’ current mood.

Stocks were not the only financial market disrupted after the Brexit announcement, foreign exchange currency rates were unstable as well. The British pound dived to a 30-year low shortly after the vote to a level of approximately $1.33/£, and was down more than -10% on the day of the announcement (see chart below). UK banks like Barclays PLC (BCS) and Lloyds Banking Group PLC (LYG) also saw their share prices significantly pressured as EU regulatory risks of losing access to European customers and negative global interest rates further squeeze the banks’ profit margins.

To put the currency picture into perspective, the value of the British pound ($2.64/£) peaked in March 1972 at a rate about double the U.S. dollar today. On the positive side of the ledger, a weaker British pound could help boost exports and vacation time to Stonehenge or London, but there is also a risk for a spike of inflation (or stagflation) on the country’s roughly $740 billion in imports (e.g., food, energy, and raw materials).

currency v ppp

Source: Calafia Beach Pundit

Why Did it Happen?

While economically prosperous regions like London and Scotland voted heavily for Remain, the message for change of the Leave camp resonated well with working class towns and rural areas of England (seen here). Besides a geographic split, there was also a demographic divide between voters. As you can see from the YouGov poll below, the majority of younger citizens overwhelmingly voted for Remain, and vice versa for older citizens as it relates to the Leave vote.

18-24: 75% Remain

25-49: 56% Remain

50-64: 44% Remain

65+: 39% Remain

While geography and demographics certainly played a key role in the outcome of the EU Leave referendum result, at the core of the movement also was a populist discontent with immigration and the negative economic consequences created by globalization. There are many reasons behind the sluggish economic global recovery, even if the U.S. is doing best out of the developed countries, but rightly or wrongly, immigration policies and protectionism played a prominent part in the Brexit.

At the heart of the populist sentiment of lost control to Brussels (EU) and immigration is the question of whether the benefits of globalization have outweighed the costs. The spread of globalization and expanded EU immigration has disenfranchised many lower skill level workers displaced by eastern European immigrants, Syrian refugees and innovative solutions like automated machinery, software, and electronic equipment. Economic history clearly shows the answer to the effectiveness of globalization is a resounding “yes”, but the post-financial crisis recovery has been disappointingly sluggish, so a component of the populist movement has felt an urgency to find a scapegoat. The benefits of globalization can be seen in the chart below, as evidenced by the increases in per capita GDP of the UK relative to Germany and France, after joining the EU in 1973. Many observers are quick to identify the visible consequences of globalization (i.e., lower-paying job losses), but fail to identify the invisible benefits (i.e., productivity, lower prices, investment in higher-paying job gains).

UK GDP Ratio

Source: The Wall Street Journal

What happens next?

While some EU leaders want to accelerate the Brexit transition, in actuality, this will require a long, drawn-out negotiation process between the still-unnamed new UK Prime Minister and EU officials. The complete EU-Brexit deal will take upwards of two-years to complete, once Article 50 of the EU Lisbon Treaty has been triggered – likely in October.

In light of the unchartered nature of the Brexit Leave vote, nobody truly knows if this decision will ultimately compromise the existential reality of the EU. Time will tell whether Brexit will merely be a small bump on the long EU road, or the beginning of a scary European domino effect that causes the 28 EU country bloc to topple. If the U.K. is successful in negotiating EU trade agreements with separate European countries, the Brexit even has a longer-term potential of benefiting economic activity.  Regardless of the EU outcome, the long-term proliferation of capitalism and democracy is likely to prevail because citizens vote with their wallets and capital goes where it is treated best.

What does Brexit Mean for Global Markets?

The short answer is not much economically, however there have been plenty of less substantial events that have roiled financial markets for relatively short periods of time. There are two basic questions to ask when looking at the economic impact of Brexit:

1) What is the Brexit impact on the U.S. economy?

If you objectively analyze the statistics, U.S. companies sold approximately $56 billion of goods to the U.K. last year   (our #7 trading partner). Even if you believe in the unlikely scenario of a severe U.K. economic meltdown, the U.K. trade figure is a rounding error in the whole global economic scheme of things. More specifically, $56 billion in trade with the U.K. equates to about .003 of the United States’ $18+ trillion GDP (Gross Domestic Product).

2) What is the Brexit impact on the global economy?

The U.K.’s GDP amounts to about $3 trillion dollars. Of that total, U.K. exports to the EU account for a reasonably insignificant $300 billion. As you can see from the chart below, $300 billion in UK exports to the EU are virtually meaningless and coincidentally equate to about .003 of the world’s $78 trillion estimated GDP.

global gdp

Source: The National Archives

What to Do Next?

Like many divorces, the U.K. Brexit may be messy and drawn out, until all the details are finalized over the next couple years. It’s important that you establish a strong foundation with your investments and do not divorce the sound, fundamental principles needed to grow and preserve your portfolio. As is usually the case, panicking or making an emotional decision relating to your investments during the heat of some geopolitical crisis rarely translates into an optimal decision over the long-run. As I repeatedly have advised over the years, these periods of volatility are nothing new (see also Series of Unfortunate Events).

If you catch your anxiety or blood pressure rising, do yourself a favor and turn off your TV, radio, or electronic device. A more productive use of time is to calmly review your asset allocation and follow a financial plan, with or without the assistance of a financial professional, so that you are able to achieve your long-term financial goals. This strategy will help you establish a more durable, long-lasting, and successful marriage with your investments.

investment-questions-border

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

July 2, 2016 at 9:00 am Leave a comment

Brexit Briefing

Pair of British Briefs

Pair of British Briefs

There is no shortage of Brexit articles, but as I compile information for my monthly newsletter later this week (subscribe at Investing Caffeine – right column), here are some of my favorite links:

1) How to Make Sense of the Brexit Turmoil (FiveThirtyEight)

2) Brexit Meltdown Charts (Ritholtz)

3) House of Commons UK-EU Economic Relations Report (Parliament Research Briefings)

4) What is article 50 and why is it so central to the Brexit debate? (The Guardian)

5) The Difference Between the EU and Euro Zone (Moody’s)

6) Brexit’s First 100 Days (Bloomberg)

7) Brexit Impact on Wimbledon Paychecks (Fox Sports)

8) Relationship Between the U.K., Britain, England, Great Britain, Ireland, Northern Island, Wales, and British Isles (Project Britain)

9) Brexit Voting Results by Age (Ben Riley-Smith – Twitter)

10) Brexit Impact on Global Economy (Wall Street Journal)

11) Brexit is Not the End of the World (Calafia Beach Pundit)

investment-questions-border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds , but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

June 26, 2016 at 12:25 pm Leave a comment

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