Stock markets around the world have grown more volatile in recent days. One reason: what many people now know as “Brexit” or today’s vote in Britain to determine whether the U.K. will stay in the European Union or begin to exit the political and economic partnership. And like many major political decisions, the lead up to the vote has been weighing on the markets and on the minds of U.S. investors.
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As most academics and policymakers agree, there are a variety of economic implications of the vote. Exiting the European Union would likely be negative for Britain, and to a lesser extent Europe.
According to the Fidelity Asset Allocation Research team framework, the U.K. is currently in the latter stages of the mid-cycle phase of the business cycle. Business activity and sentiment have weakened ahead of the vote, but consumer demand is holding up and the economy remains in a slow but steady expansion.
A vote to exit would likely hurt business sentiment and investment immediately. The big problem is the uncertainty surrounding what future rules will govern the U.K.’s commercial relationship with the EU. There is no template for a country exiting the EU — it has never happened before. The rules say there is a two-year window for the EU to determine how they want to treat commerce after the exit.
The U.K. relies on exports to other EU countries for nearly half of its exports, but the preferential trade access the country enjoys as part of the EU could be eliminated. The U.K. is the center of Europe’s financial system, but the regulatory treatment of its financial operations on the continent may change. This uncertainty — and the fact it could take years to sort out the new relationship — is likely to weigh heavily on U.K. business decisions.
The uncertainty also is likely to slow economic activity in the near-term. I’m not sure whether it would be enough to shock the economy into a recession, but I certainly expect it would be a negative short-term event for the U.K.
For Europe, the story is more complex. Europe does not rely on the U.K. as a market for exports to the same extent, and if the financial services industry in London were displaced, over time it might actually bring business to other European financial centers. At the same time, a vote to exit would raise a lot of questions about the stability of Europe in terms of the political support for European integration. This is more difficult to measure in terms of near-term economic impact, but it is also likely to hurt business and investor sentiment. Overall, I think it would be negative for Europe's economy, but perhaps not to the same extent as the U.K. itself.
So what could a vote to exit the EU mean for investors? Certainly, if the U.K. votes to leave it could be a near-term negative for investor sentiment. We’ve seen that in recent days, as global equity markets have become jittery amid new polls that show rising support for Brexit. A vote to leave would raise questions about both the U.K. and the future of other countries in the EU. So, in the event of a vote to exit, you won’t have clarity, you will have more uncertainty. And this comes at a time when the global economy is struggling to regain traction, so any additional headwinds just make the environment that much more difficult.
Generally, more uncertainty means investors want to take less risk. That could set a negative near-term tone for global stock markets, and U.K. stocks and the pound in particular, but also the euro currency. In such a risk-off backdrop, the U.S. Treasury may be seen as a safe haven, so a vote to exit might continue the Treasury rally and support the dollar.
And what could a vote to remain in the EU mean for U.S. investors? My basic outlook for the U.K. and European economies is for a continued economic expansion. So if the vote is to remain it would remove some uncertainty, and that would be incrementally positive for corporate sentiment and the business cycle.
I think this scenario would have a smaller impact in the currency, stock, and bond markets. Despite recent unease among investors, a vote to remain has generally been more widely expected. Still, a vote to stay would be a net positive and could support U.K. and EU currencies and stocks. If markets continue to sell off and price in a higher probability of Brexit, the potential for a broader-based relief rally in U.S. and global equities would probably rise.
Regardless of the results, what should investors take away from vote? The referendum itself is evidence of some broader political tensions. In recent decades, technological advances and global policy initiatives have accelerated trends toward greater global economic integration. These trends fostered a global boom through the mid-2000s, but they have also given way to concerns by citizens in some countries that the gains have been unevenly distributed and too much control has been ceded to supra-national authorities. We are carefully monitoring how these political risks may influence the corporate backdrop and outlook for asset allocation over time.
The bottom line for investors? The key to weathering market volatility is preparation. It’s impossible to predict the direction of the markets, but there are certain principles investors can follow to help develop a sound-investing plan for the future. We encourage customers to review their investment objectives. If they have long-term objectives, then it may be appropriate to continue on a steady investment course. We believe that taking a long-term view is much more effective than trying to time the market.
Attempting to move in and out of the market can be a costly affair, particularly because a significant portion of the market’s gains over time have tended to come in concentrated periods. No matter what a customer's investment time horizon, it makes good sense to follow a regular investment plan, investing a certain amount of money in a fund at the same time each month or quarter and periodically reviewing the overall portfolio.
Lisa Emsbo-Mattingly is Director of Research, Global Asset Allocation Research, at Fidelity Investments. The firm oversees $5.2 trillion in customer assets.
*This article [portions of] was previously published by Fidelity.
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