The United Kingdom’s unexpected decision to leave the EuropeanUnion sent markets reeling in late June. On June 24, 2016 the S&P suffereda 3.6% decline, its worst day of 2016. But that loss was muted in comparison tothe 8.6% drop in Europe’s EURO STOXX 50 Index — its biggest one-day loss in30 years — or the nearly 9% drop in the British pound versus the U.S. dollar to a31-year low. Investors fled to safe havens such as U.S. Treasuries, the U.S. dollar, and gold amid the political uncertainty. Let’s look at the potential U.S. economic, earnings, and market implications of this historic event — the first reversal after many decades of European integration.
POTENTIAL ECONOMIC IMPACT
We expect minimal impact on the U.S. economy from the Brexit even though the odds of a U.S. recession in the next 12 – 18 months may have risen slightly. The stronger dollar from tightening financial conditions will be a slight drag on U.S. exports, but exports only represent about 15% of U.S. gross domesticproduct (GDP), and the U.K. composes just a small fraction of that. Even the much larger EU, which will see some negative economic impact from breakingtrading ties with the U.K., comprises just 17% of U.S. exports
POTENTIAL EARNINGS IMPACT
The Brexit will have some negative impact on corporate profits through a stronger U.S. dollar. We expect that tightening financial conditions, lower interest rates, and U.K. exposure will likely have some incremental negative impact on financial sector profits. The good news is most companies have minimal exposure to the U.K., and the U.S. dollar is little changed over the past year against the global basket of currencies that make up the U.S. Dollar Index.
We know markets do not like uncertainty, and the U.K.’s vote to leave the EU has introduced new economic and political uncertainty that likely won’t go away quickly; but there are enough positives for this market to give us the confidence that 2016 can still be a positive year for U.S. stocks. We may be in for some more volatility, but long-term investors should stick to their plans. More tactical investors may want to consider a slightly more conservative stance in the near term until we have more clarity on the political landscape. The summer is seasonally weak for stocks historically and the U.S. election still has the potential to cause volatility.
President, Blue Diamond Wealth Management
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