Implications of the Brexit

June 24, 2016

brexit imageThe Brexit vote for Britain to leave the EU has triggered a selloff in global equity markets although the impact in the U.S. is modest so far, with major indices down significantly thus far today. Clearly, investors across the world were caught leaning the wrong way on the Brexit vote, and the short-term reaction has been sharp and painful. In this note, we focus on our view from a longer-term perspective.

It is important to remember that the vote is a non-binding referendum, and the full implications of Britain leaving the union are not yet fully understood. Most likely, it will take several years before the decision will actually filter down to changes in trade agreements, which practically speaking, is the biggest implication for the UK.

We believe the more profound implication of Brexit is the possible contagion effect of other EU members considering the same option. Substantial Euro-skeptic factions exist in France, Spain, Italy, and Germany. An exit by one of these countries could jeopardize the Euro as a currency and could create a dislocation in global markets as investors flee to assets denominated in alternative safe-haven currencies. While this is always a possibility, it does not seem to be an imminent threat at this time.

While the possible demise of the Euro may not be imminent, it does represent an overhang on European investments. For that reason, in the near-term we do believe there will be a period of elevated volatility in global markets and a sustained flight-to-quality to prevail globally. Central banks have stepped up in the last day to assure markets that they will provide whatever liquidity is needed to support price levels, suggesting that lower-rates-for-longer periods of time could continue as an ascendant investment theme.

Given the political and economic uncertainties in the EU, and the low level of interest rates across developed economies, we believe investors will continue to embrace U.S. dividend paying stocks as one of the more compelling alternatives on a risk-adjusted basis. When the dust from Brexit settles, assuming global markets stabilize fairly quickly, at some point later in the year the U.S. Federal Reserve will begin to worry again about fighting inflation. With the underlying strength of the U.S. economy, we think a rate increase toward the end of this year remains on the table, which further supports the dollar and domestic financial markets.

The views expressed are those of Washington Trust Wealth Management and are subject to change based on market and other conditions. The information provided is solely for informational purposes and has been obtained from sources believed to be reliable but its accuracy is not guaranteed. All information is current as of the date of this material and is subject to change without notice. The information provided does not constitute investment, legal, accounting or tax advice and it should not be relied on as such. Please consult with a financial counselor, attorney or tax professional regarding your specific investment, legal or tax situation.

Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, political, regulatory, geopolitical, and other conditions. Investments in foreign markets through issuers or currencies can involve greater risk and volatility than U.S. investments because of adverse market, economic, political, regulatory, geopolitical, or other conditions. Emerging markets can have less market structure, depth, and regulatory oversight and greater political, social, and economic instability than developed markets. Fixed Income investments, including floating rate bonds, involve risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. Interest rate risk is the risk that interest rates will rise, causing bond prices to fall.

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