Second Quarter 2016 Commentaries

A Non-Expert View on “Brexit”


“How may I serve you, Sir?” Thus spoke a pretty brunette with an Italian accent as I stepped to the counter at The Café Nero on the corner of Arlington and Piccadilly Street. That was the breakfast purveyor of my choice during my recent visit to London. Such is the benefit of a

European Union. The restaurants and shops of London are heavily staffed by young men and women from Southern and Eastern Europe as the free movement of labor within EU affords them the opportunity to work in this great metropolis.


On August 23, the people of United Kingdom voted by a margin of 52% against 48% that such arrangements are not working out for them. The passage of the so called “Brexit” referendum instructs the parliament to initiate the process so that Britain may extricate itself from the European Union.

For the financial market, it was instant chaos.

During the immediate aftermath, stocks in Tokyo were down 7.9%. Hong Kong stocks were down 2.9%. British Stock Index FTSE was off by 3.15%; whereas the French index CAC was walloped by 8.04% and German DAX was trounced by 6.8%. In the US, stocks opened off by just over 3%. Buyers made a valiant appearance during midday, but were ultimately swapped by sellers. S&P 500 closed down 3.6%. Things were equally chaotic in the commodity and currency markets. WTI crude was off by 5% and copper was down by 2.4%. The Euro lost 1.7% against the dollar and the Pound was chopped 6%. Meanwhile, perceived safe heaven trades thrived. The Yen, Gold and Treasury all enjoyed a day of rising prices.

The severity of the market reaction was partially a result of its complacency. Stocks around the world had rallied ahead of the “Brexit” vote. Financial pundits almost uniformly predicted a close vote with the “remain” side ultimately prevailing. “Why would the people of Britain commit economic self harm?” As the actual voting result came in, the experts were dismayed and dire predictions filled the airwave. “A crisis as bad as 2008 has been unleashed,” predicted George Soros. “There will certainly be a recession,” wrote Martin Wolfe. Yet after many months of campaign and numerous lectures by world leaders and economic experts alike on the economic harm of “Brexit,” the percentage of British population who agreed with this assessment remained unchanged at about one third. Clearly, the people have lost faith in the experts.


Post the “Brexit” vote, Alan Greenspan, the former Chairman of the Federal Reserve, commented what happened was merely “the tip of an iceberg” because “real incomes are not going anywhere.” The financial crisis of 2008 seems to mark a turning point in the economic growth of both Europe and United States. In the United States, real household disposable income had grown at an annual rate of 2.94% from 2000 to 2008. But since 2008, real incomes have averaged only 0.78% growth. The United Kingdom exhibited similar patterns with prior 2008 growth at 2.72% and post 2008 growth of 1.21%. The statistics were even more telling for southern European nations. Before the great recession, real disposable income for Greece, Spain and Italy had grown 3.53%, 3.44% and 1.21% respectively. Since then, contraction had become the norm and real income for these countries had fallen on average of 5.36%, 0.66% and 1.24%. To make the matter even worse, even as total incomes have shown slower growth, the distributions of said growth have favored the top wage earners. The inevitable consequences of slower growth and inequitable distribution were clearly demonstrated by a recent Pew Research study that showed number of people in both the upper and lower income tiers have increased while middle class had shrank.

So it is a time of prosperity and anxiety; a time of full employment and insecurity; a time of mobility and quandary. It is a time that brings out specters. In Europe and America, the specters of populism are on the march. There is a perception among the people that political parties on the left and right despite rhetorical differences are largely impotent in solving the problems of inequality and slow growth. Their policy initiatives have favored the elites of the society at the expense of the working class. So in Greece, we witnessed Syriza Party which incorporates elements of socialism and populism took control of the country in 2014. Despite its campaign promises of debt extinguishment and wage increases, it ultimately had to accept restructuring and austerity largely on terms set by the European Union. Since then, such left leaning versions of populism have achieved some degree of success in many Southern European nations. However, in Northern Europe, the right leaning versions that unite nationalism with populism have found greater success. They are best exemplified by Finns Party of Finland which is a member of the current ruling coalition. The “Brexit” movement can also be best viewed as a left leaning populist coalition. In the United States, both versions of populisms are on full display during the 2016 presidential election cycle.


After two days of post “Brexit” decline, stocks have staged three days of rally to close out the second quarter. The S&P 500 closed at 2085 on June 22 before the vote. It fell to 2000 two days after the vote. On June 30, it is less than 2 points away from 2100. I suppose the stock market has found kindred spirits with the “leave” side and rejected the experts’ prediction of imminent and dire consequences too. For US stock investors, the uncertainty of “Brexit” will certainly bind the hands of the Federal Reserve which means any possibility of interest rate hike would have to wait until year end. That is of course constructive for equity valuation. Yet ameliorating earnings environment tentatively established during the first quarter due to easier comparison for energy stocks and more benign appreciation for the dollar will certainly take a turn for the worse. It is now extremely unlikely we will see any earnings growth for S&P 500 until the last quarter of the year. That is of course negative for the market. In stock investing, a more forgiving liquidity and valuation environment tends to win over slower earnings growth. In any case, “Brexit” can be hardly characterized as a disaster for US equity investors; hence the rally was just as swift as the fall.

“Brexit” does not mark a new era, but is an event within the post financial crisis environment of slow growth. So to see the future, it is best to look east at Japan. For Europe and United States, the great recession of 2008 marked a seminal event. For Japan, the bubble was burst in 1989. Despite many rounds of fiscal and monetary stimuli, it has remained in a slow growth environment for nearly 30 years. “Brexit” would not end fiscal stimulation or economic stagnation, but rather it seems to prolong, if not perpetuate it, just like they have in Japan. Of course, now that the whole world seems to be getting into the act of monetary easing, one must also be cognizant of the possibility that the central bankers of the world may one day succeed in making money so abundant and goods in comparison relatively dear. That would be the day that the experts would not only have lost the people, but also lost control. For my money, so long as the central bankers keep trying yet not succeeding, the strategic imperative would be keep invested.