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Brexit and global financial market response

- Kent Kramer, CFP, AIF, is chief investment officer/lead adviser at Foster Group. He writes about investing for IowaBiz.com

“It’s tough to make predictions, especially about the future.” Yogi Berra

A Yogi Berra quote may seem a bit too lighthearted as an opening thought regarding the momentous “Brexit Leave” vote and the immediate reactions, financially and politically, around the world. Though the quote is humorous, the point is an important one for investors to consider. Reliably predicting future events has been hard to impossible in the past, and there is no evidence that it is getting any easier. Just ask the bookmakers in the UK who were offering very favorable odds of a “Remain” vote just 24 hours prior to the actual vote tally.

International stock markets virtually all declined following Thursday’s vote, some more severely than others. However, these declines came on the heels of some significant gains as many traders were predicting the UK would vote “Remain,” even as polling data showed a statistical dead heat between the “Remain” and “Leave” options. On Monday, June 20, the FTSE 100 Index of British Stocks opened at 6126.27. On Friday, June 24 at close (the day after the vote), the same stock market index was at 6138.691. Actually higher than where it began the week before! Other global markets showed heightened volatility for the week, with declines on Friday and Monday reflecting the general uncertainty about “Brexit’s” longer-term effects on markets and economies.

Jason Zweig, writing in his Wall Street Journal column on Friday, reminded investors of the counter-intuitive nature of stock market returns and economic news over time:

“…investors should remember that there is a perverse correlation between economic growth and stock-market returns. Research by Prof. Dimson and his colleagues Paul Marsh and Mike Staunton of London Business School has shown that, in the long run, countries with the fastest economic growth tend to have the lowest stock-market returns, and vice versa.”

That’s because investors overpay for optimism and underpay for the value that pessimism creates.

“Just uttering the words ‘When will this pay off?’ should tell you that it will, and fairly soon,” says William Bernstein, an investment manager at Efficient Frontier Advisors in Eastford, Conn. “You don’t get bargain prices anywhere without the presence of really bad news.”

It’s important to remember, in general, financial markets do not respond positively to uncertainty or surprise. Ben Casselman, the website FiveThirtyEight’s chief economics writer, had this to say (among other things) in his Friday post, “How to Make Sense of the Brexit Turmoil”:

“Ignore the initial market reaction: The initial reaction will tell us next to nothing about the longer-run impact a Brexit will have on markets or the broader economy. Market turmoil was probably inevitable after a decision this momentous, and it will be made worse by the fact that the outcome was a surprise: Despite polls showing a close race, most investors expected the “Remain” side to prevail in the end. … Most ordinary investors are probably best off logging out of their E-Trade accounts and tossing out their 401(k) statements, at least for a couple of weeks.”

As a practical matter, Foster Group continues to advise investors to maintain a clarity of purpose around their overall portfolio. For anyone in retirement, or needing dollars from their portfolio in the next five years, these anticipated cash flows should already be invested in short-term, high-quality bonds (e.g., Short-term US Treasuries and high-grade one- and two-year corporates). These short-term reserves may actually experience some gains in the near-term as global investors, in a “flight to quality”, seek to own more US government bonds and high-quality issues. Friday, June 24 saw the price of the 10-year US Treasury rise by more than 1.5 percent1 on this increased demand.

For the longer-term growth component of portfolios, a broadly diversified allocation to global stocks, bonds, and real estate offers a much higher probability of success (growth well above future rates of inflation) than trying to predict which specific asset classes or regional stock markets may do better or worse in the coming months.

Peter Westaway, Ph.D., chief economist and head of the Investment Strategy Group for Vanguard Asset Management, Limited, Vanguard’s European entity, wrote this following the Brexit outcome:

“Of course, Vanguard discourages market-timing moves, and by now, much of this effect is already priced into asset values…Given that it may take several years for the specifics of Brexit to play out, and markets may be rattled as plans take shape, investors' best protection is to hold a portfolio that is diversified across asset classes and regions.”

It is always disconcerting to watch financial markets and portfolio values fall so quickly. We only need think back to January and February of 2016, as global stock markets declined in many cases more than 10 percent before recovering and moving into positive territory for the year. The often tough thing to do during these events is to remember that careful planning and portfolio building done in calmer days was designed to enable you to weather, and ultimately thrive, despite surprisingly unpredictable events.

  1. Index and return data as published in the Wall Street Journal Online Edition, June 24, 2016

PLEASE NOTE LIMITATIONS: Please see Important Disclosure Information and the limitations of any ranking/recognitions, at www.fostergrp.com/disclosures. The above discussion should be viewed in its entirety. The use of any portion thereof without reference to the remainder could result in a loss of context. Foster Group cannot be responsible for any resulting discrepancy. A copy of our current written disclosure statement as set forth on Part 2A of Form ADV is available at www.adviserinfo.sec.gov.

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