The fallout from the Brexit vote continued for a second day, with another round of selling in most major equity markets and another advance among risk-off assets. If you are keeping score, S&P’s Howard Silverblatt tweeted that Friday’s selloff lopped $2.1 trillion off global equity values, the largest one-day drop ever.
The political earthquake in Europe has already claimed the career of British Prime Minister David Cameron. And, if it already hasn’t been said, I’ll say it: the British pound has gone on a crash diet, falling to the lowest level against the dollar in over 30 years. It’s going to be a big plus for British exporters, but it will likely stoke inflation in the U.K.
But as the political fallout continues, many at home are asking how this will affect our financial markets and our economy. No one has a crystal ball. But before I take a stab at it, let me explain the short-term rout in stocks.
Political pundits and analysts had expected the Remain camp to squeak out a win. In anticipation, markets rallied as the vote approached. But Thursday night’s “surprise” was analogous to a swift and unexpected kick in the gut. Hence, we seeing a re-pricing/re-adjustment of risk.
In other words, investors are surveying the new economic landscape and trying to settle on a new value for the market as a whole. It is uncharted territory for the markets, which creates volatility.
It’s not that a recession in the U.K. (if it were to occur) would, by itself, sink the U.S. economy. It won’t. But fears and uncertainty swirling around the referendum have raised concerns that other nations might find Britain’s path to be an attractive one. Then, there are renewed worries that the euro itself might eventually collapse.
One thing that’s certain: equity markets hate heightened uncertainty, and that’s what’s been playing out over the last couple of days, especially among the financials.
So back to the question: how will this affect the U.S.? It’s hard to see how this alone becomes a Lehman moment that crashes into the credit markets and destroys liquidity.
Banks in the U.S. are in much better shape today, and the consumer is healthier than in 2008. Yes, there are weak spots, such as business spending, but when Lehman Brothers imploded, the U.S. was already in a modest recession. Today, the economy is expanding, albeit modestly.
A better question for long-term investors
Will this impact your portfolio five or ten years from now? Again, no one has a crystal ball, but I suspect the answer is no.
Historically, the U.S. economy and corporate profits hold the biggest sway over the medium- and long-term direction of U.S. stocks, not what happens around the globe.
Whether the tragic earthquake in Japan, the Arab spring, the 2011/12 eurozone debt crisis, chaos in Iraq and Syria, or Russia’s invasion of Ukraine, the spotlight normally returns to domestic events.