Originally posted at Briefing.com.
That thing that wasn't supposed to happen has happened. A majority of voters in the UK voted in favor of leaving the European Union. It was an historic decision, the full implications of which are unknown and won't be known for years.
The first implication, however, is that it has created a heightened sense of uncertainty that has reverberated in capital markets around the globe.
Pow! Goes the Status Quo
In our preview of the Brexit vote on May 20, we highlighted for readers why a winning "Leave" vote would be particularly disruptive. Briefly, we said then that it would be disruptive because it would blow up the status quo and usher in a heightened sense of uncertainty.
The gist of the matter is that the vote wasn't just about the UK. It was about the standing of the European Union, which is now looking more wobbly than it was a short time ago when it was presumed by the financial markets that the "Remain" camp would prevail.
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The European Union was far from a perfect union in front of the vote, but now that one member has voted to walk away because it didn't like the terms of its membership, there is added political, social, economic, and financial risk for a region that needs less of all of those risks.
It is hard to say what the Brexit vote means specifically for the United States. One thing we can say with certainty is that the spillover effect won't be zero. The fallout in the stock market after the Brexit vote makes that abundantly clear.
There is a lot to think about now—a lot more anyway than there would have been had the "Remain" camp won. Admittedly, I'm still thinking through it all, but today I wanted to offer some initial impressions pertaining to the decision by the majority of UK voters to leave the European Union.
Making a List
Democracy worked
The sharp losses following the vote will create further disillusionment for individual investors when it comes to investing in the stock market.
There can be a very high price to pay for complacency—and the capital markets were far too complacent in the week leading up to the vote in the thought that the "Remain" camp would win.
It's silly to get overly committed to a trading position right in front of an event that carries asymmetric risk if one is not properly hedged to deal with an unexpected outcome.
There are understandable concerns that the UK vote will encourage a push for similar referendums in other EU countries. If the fallout in financial markets persists, EU members elsewhere may rethink that effort so as not to risk further financial pain.
Connections will likely be made that the decision by the UK to leave the European Union underscores a wave of discontent about the status quo that could also surface in the November election in the US.
A pickup in earnings growth in the second half of the year is going to be called into question with the spike in the dollar, the drop in oil prices, the volatility of the financial markets, and the increased uncertainty, which seem likely to impede business investment.
The Federal Reserve won't be raising the fed funds rate in July, because it will need more time to determine what economic ramifications there are now in the wake of the Brexit vote and financial market volatility. Moreover, dollar strength acts as an effective tightening of policy since it will crimp export growth and help hold down inflation.
The Brexit vote makes the Fed's decision to hold off on raising rates at the June meeting look better than it did only a week ago—BUT—at the same time it exposes just how little room the Fed has to maneuver with interest rates in the event there is some significant financial market and/or economic dislocation.
Portfolio diversification, with a mix that includes government bonds and precious metals, has served its purpose as the exposure to US Treasuries and precious metals has helped cushion some of the blow from the stock market selloff.
There is more downside risk for global economic activity with the winning "Leave" vote than there would have been upside potential in a winning "Remain" vote.
Stocks go down a lot quicker than they go up, and that really rings true when starting from a point of high valuation like this market was.
What It All Means
As noted above, it's impossible to know what it all means at this juncture. The UK's divorce from the European Union will be a multi-year happening.
In due time capital markets will adjust to this new reality, yet the short term could feature a lot more volatility since this is something so new—and, frankly, surprising—that central bankers, government leaders, and professional money managers still need time to figure out.
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The only clear deduction today is that it has unleashed a lot of new uncertainty for all parties. Our suspicion is that it has probably also triggered a fair number of margin calls for some parties that have led to forced selling that has exacerbated the Brexit-related losses.
Just as we observed in our Market View update last week, though, this market had its fundamental challenges before the Brexit vote. It would have still had them even if the "Remain" camp had prevailed.
The recognized fact today that the "Leave" camp won simply adds to those fundamental challenges, which drive our belief that stock market return expectations this year should be held in check.
