Brexit vote roils markets

Our experts say now is the time to focus on your long-term goals.

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The United Kingdom (U.K.) vote on June 23 to exit the European Union (EU) sent shock waves through European and U.S. markets Friday, as investors began to digest the far ranging implications of this historic vote.

After rallying on Thursday on optimism that the Brexit vote would fail, the FTSE 100 was traded down sharply on Friday, falling close to 9% at one point, before closing down 3.15%. The British pound fell by nearly 8% the day after the vote, to a 30-year low, and the euro fell 2.4% against the dollar. Meanwhile, the ripple effects were felt across the pond as the S&P 500® Index fell 3.6% on Friday and Treasuries rallied. Oil prices were down nearly 5%. In the U.S., the only sector with positive performance was utilities.

“Now that Brexit has passed, I think it’s important to step back, and just watch how things play out,” says Bill Bower, portfolio manager of the Fidelity® Diversified International Fund (FDIVX). Bower expects continued uncertainty and currency volatility, particularly some weakness in the euro, given the dimension of the breakup. “It would be like the United States losing California as a trading partner,” he explains.

"But the real unknown is what happens to other countries who are on the fringe—should we stay or should we go,” adds Bower. “That’s what I will be watching for over the longer term. And then just because it’s happened doesn’t mean it’s over. I am expecting more discussions about the conditions that could be met to keep the U.K. in the European Union.”

His message for individual investors in the face of this uncertainty and market volatility: “Continue to think longer term.”

For a more in depth discussion of the fallout from the Brexit vote, Viewpoints caught up with Dirk Hofschire, senior vice president of asset allocation research on Fidelity’s Asset Allocation Research Team. The highlights of our discussion:

Q: What are the economic implications of the vote?

HOFSCHIRE: From an economic perspective, most academics and policymakers agree that exiting the European Union will 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.

The vote to exit will 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.

This uncertainty is likely to slow economic activity in the near-term. I’m not sure whether it will 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 raises 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 will be negative for Europe's economy, but perhaps not to the same extent as the U.K. itself.

Q: What could a vote to exit mean for investors?

HOFSCHIRE: Certainly, the U.K. vote to leave has roiled global and European markets. The most vulnerable of the European markets, Spain and Italy, were down more than 10% on Friday and even Germany was down approximately 7%. As I mentioned, a vote to leave also raises questions about both the U.K. and the future of other countries in the EU. So, ultimately the vote to exit, means 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.

Q: What does the vote mean for the U.S. economy?

HOFSCHIRE: The vote to leave likely has little direct impact on the U.S. economy over the long term. U.S. economic trends are heavily driven by the U.S. consumer (roughly 70% of GDP), which continues to benefit from tighter labor markets and rising income expectations (see the June business cycle update) that are little impacted by the vote in the U.K. While business activity has moderated some of late, the underlying trend there has remained solid as well. As a result, our U.S. macro view has not changed—the U.S. continues to experience a mix of mid- and late-cycle indicators, and the odds of recession remain low.

Q: What should investors take away from this issue?

HOFSCHIRE: The vote is evidence of some broader political tensions and we’ve already seen British Prime Minister David Cameron resign in the wake of the vote to leave the U.K. 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.

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Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
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