The Brexit: A Threat to Global Markets?

Editor’s Note: Since this article was originally published, Britain has voted to exit the European Union (EU).

“Patience and perseverance have a magical effect before which difficulties disappear and obstacles vanish.” — John Quincy Adams

The British are leaving? On June 23, British citizens will vote to decide whether the U.K. should leave or remain in the European Union (EU). The most recent polls, while close, show a majority of Britons intend to vote to leave the EU. The arguments to leave include: the imposition of too many rules and regulations on business, lack of control over borders, billions in annual membership fees (8.8 billion pounds in 2014/2015) and a union that is determined to have its members move closer over time, and eventually look more like a “United States of Europe.”

Those looking to stay argue that the country is more secure and held in higher regard by being a member of the 28-nation group, and that the free flow of both goods and people within the EU boosts economic growth, rather than impedes it. Each side has its perspective, and we’ll get the answer soon enough.

What happens if they vote to leave?

Markets will certainly react and have already started to pay more attention to the polls; what happens beyond the markets is a slow, extended process of negotiations between the U.K. and the EU on how the exit will be implemented. This process is expected to take at least two years. Through the negotiation period, the U.K. will continue to abide by its existing EU commitments. So global markets will absorb the immediate news, and then continue to monitor the negotiations and deal with all the other economic and geopolitical news that will also surely develop.1

What about international markets?

With Europe and Japan struggling to generate consistent, robust economic growth (in spite of the near-zero and even negative interest rates), and continued angst about emerging markets like China, Brazil and Russia, what’s the case for investing outside the United States?

The Brexit: A Threat to Global Markets?

The current case revolves around valuation. Stocks around the globe are cheap, relative to their own history and to U.S. equities. Markets like the U.K. and Japan are trading in the bottom quartile of their respective historical valuations; emerging markets are trading in the bottom decile, while U.S. valuations are trading above median valuations.

The primary driver of future returns is not likely economic growth, but rather low valuations. Price really matters — cheap markets, in which investors have been underweight, typically react very quickly to any incremental improvement in the outlook for recovery. Missing those turns can impact long-term returns tremendously. Look at the U.S. market history, as an example: missing just the 30 best trading days since 1980 cuts long-term returns almost in half!

Source: Cambridge Associates

Even though international stocks are relatively inexpensive, it is difficult to say when the market outlook for these stocks might change, which is why maintaining an allocation to both international and domestic equity markets is important. Maintaining a globally diversified portfolio helps ensure that you participate in positive market returns wherever they may occur.

Emerging markets are taking the lead so far this year.

Going into 2016, emerging markets had been suffering through an extended period of underperformance, culminating with a drop of 14.6% in 2015. Falling commodity prices, political instability, slowing growth in China and anticipation of Federal Reserve rate hikes all contributed to the drop.

Investment sentiment was terrible, and many investors had given up on the emerging markets at the start of the year. Just when it looked hopeless, oil prices and China’s economy stabilized, and so far the Fed has not raised rates this year. Emerging markets are now leading global markets with a year-to-date return of 6.3% through June 9.

From a valuation perspective, international markets (including emerging markets) look very attractive. It is very hard to predict when, exactly, the next economic upcycle will take hold in these markets, but the low valuations limit downside, as we wait for the return potential to develop in the months and years ahead. The low valuations also help markets get through challenges like the upcoming Brexit vote. We are as confident as ever that over time, patience, perseverance, discipline and diversification will continue to pay off, and that meaningful exposure to foreign markets is an essential element to meeting long-term return objectives for all investors.


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OneBite Editorial Staff

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The Brexit: A Threat to Global Markets?

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