MARKET COMMENTARY

Brexit and Your Portfolio

A Political Crisis, Not a Financial One

06.27.2016 - Ronald J. Sanchez

The UK's decision to exit the European Union (EU) caught many participants, policymakers and pollsters by surprise last Friday, sending shockwaves through the global markets. The immediacy and the sheer magnitude of the market downdraft indicates to us that investors were expecting a much more favorable resolution to this drawn-out, acrimonious and divisive referendum.

In Europe, the most vulnerable markets felt the strongest repercussions of the Brexit vote. London's FTSE 250 Index closed down -7.2%, pushing the British Pound to a 31-year low. France's stock market fell -8% and Germany was down -7% on Friday. In the US, the S&P 500 Index slid -3.6%. Although that pullback erased most of the Index's year-to-date price appreciation, it barely put a dent in the S&P's cumulative return of 60% over the past five years.

While these selloffs are unsettling and may have long-term implications, they appear to fall short of the global market meltdown predicted by some economists and newspaper headlines. At this point, we do not believe they are a harbinger of global recession.

Proceeding with Caution

The ramifications of Brexit seem deep and far-reaching, but remain painfully ambiguous. The initial conclusion is that the decision to leave creates a high degree of uncertainty in the financial markets, but is essentially a political crisis, not a financial one.
 
In our view, the UK's breakaway from the EU turns a challenging landscape into a concerning one for the financial markets, economy and political climate.

  • Financial markets: We may continue to see a general shift away from risky assets such as equities in favor of more defensive holdings like government bonds and gold. Interest rates around the globe are likely to stay lower for longer.
  • Economy: Corporate earnings may be cloudy for some time, but it seems safe to say that these unknowns will exacerbate an already-difficult climate for capital spending, investment and hiring.
  • Political climate: It is possible that the UK's departure could have a domino effect, encouraging populist movements in other countries and leading to a fragmented Europe. Almost 28% of the portfolio managers surveyed by MSCI recently said a departure would lead to "a handful" of other countries following suit. Nationalist agendas have already gained steam in Scotland, Catalonia and other regions that are leaning toward independence.

Is Disintegration Ahead?

It is simply too early for us to accurately gauge the true, long-term impact of the decision. Too many variables could come into play.
 
But we have observed some meaningful implications in the political arena. Geographic voting patterns suggests that the Brexit vote made a strong statement about how voters view the UK's current political leadership. Prime Minister David Cameron was a vocal proponent of the "remain" camp. He has already announced his intention to resign in October 2016, but has vowed to help the UK to begin extricating itself from EU membership.

Uncertainty and Unknowns

Questions about political populism and potential contagion across the continent could challenge politicians and diplomats for years. But financial markets across the globe, including the US, are not immune to the headwinds that are likely to kick up as Britain extricates itself from the EU and other countries consider following in Britain's footsteps.

Markets do not like the unknown, and a Brexit vote creates a high degree of uncertainty for perplexed policymakers, politicians, multi-national businesses and individual investors.
 
Given the lack of clarity about the long-term implications of this referendum, in addition to the substantial economic challenges that were already weighing on European equities, our confidence in the international equities markets has weakened. Therefore, our Asset Allocation Committee's  recommendation to trim international stocks brings our tactical allocation into alignment with our longer-term strategic views on the asset class.

Our Commitment to Clients

Our Asset Allocation Committee's tactical adjustments do not diminish our confidence in the long-term discipline of global diversification.
 
Even though our general approach remains fairly cautious today, we are determined to capture pockets of opportunity on a selective basis wherever possible. Our 30 in-house investment professionals continue to monitor the situation closely, supported by Franklin Templeton's global research professionals in 35 countries across the world.

KEY TAKEAWAYS

  • Our view of international equity markets has been downgraded.

  • Still, buying opportunities may appear in global equities, commodities and currencies.

  • Friday's selloff was a rational response to political tension in the UK, not a market meltdown.

Please do not hesitate to reach out to your portfolio manager for details about Brexit and what it might mean for your particular portfolio.



This communication is intended solely to provide general information. The information and opinions stated are as of June 27, 2016, and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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