Brexit Surprise

June 27, 2016

Brexit Surprise Photo

I had an interesting perspective this past week on the reaction to the Brexit vote as I was in Scotland with some of Penn Mutual Life's top advisors. The Brexit vote to leave the European Union (EU) clearly caught the markets off guard. Going into the vote, the consensus view was that the voters in the United Kingdom (U.K.) would choose to remain in the EU. Along with the markets, U.K. betting parlors put the odds of remaining at 90% on the day of the vote. I told our advisors the day before the vote that I expected the U.K. to remain in the EU, but with a slim margin of victory. I was wrong, and the voters in England voted to leave the EU while voters in Scotland and Northern Ireland voted to remain. Scotland is already considering holding another referendum on splitting from the U.K. and immediately joining the EU.

The Brexit vote is not an isolated incident. Nationalist political movements and anti-establishment sentiment has been rising around the globe. This is all a sign that the confidence in the institutions that have kept us safe and made the world more prosperous since World War II is fading. The Brexit vote is the first major victory for voters ready to shake up the status quo. Depending on the subsequent results, it could signal more change ahead.

The immediate reaction from markets was swift across the globe, with risk markets (stocks) selling off and safe haven assets (government bonds and gold) rising in price. Overall for fixed income assets, the rally now leaves $8.7 trillion of debt worldwide trading at negative interest rates, up almost $400 million in one day. I believe the impact of the Brexit vote will continue to be more severe for fixed income and currency markets than for stocks.

Going forward, I expect an environment of increased uncertainty in both markets and geopolitical events. David Cameron stepping down as the Prime Minister of the U.K. only adds to these risks in the short term. I have been advocating defensive positioning for a while now, and I don't think this is a time where the risk/reward trade off favors adding risk. Over the next several weeks we will see the aftershocks of the vote and policymakers’ responses. Judging these responses and their potential effectiveness will be key to signaling a change in strategy.

Tags: Monday Morning O'Malley | Geo-political Risk | Politics | 2016 Outlook | Brexit | U.K. | Negative rates

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