To the surprise of most investors around the globe, yesterday the U.K. voted 52% to 48% in favor of leaving the European Union (EU), after more than four decades, in a stunning rejection of the continent's post-war political and economic order. Prime Minister David Cameron resigned, stating that he would serve another 3 months until his replacement is elected. Financial markets around the globe responded with stocks selling-off while bonds and gold rallied.
The result of the vote is important for a number of reasons, but none more than the fact that global economic growth has been fragile since the 'Great Recession' of 2008. 'Brexit' (the British from the EU) is a confidence shock to global economic growth. The U.K. now faces a period of long and drawn-out divorce talks with the EU. Under EU laws, the highly-negotiated process of withdrawal has up to 2 years to complete. The level of uncertainty and volatility in financial markets will likely remain elevated for quite some time.
In the days leading up to yesterday's vote, global financial markets were positioning themselves for the U.K. to remain in the EU. Therefore, markets were caught offside and this swift, deep sell-off is the result of an imbalance of sell orders. Within the next few days, financial markets should move back into balance. Fortunately, global central banks and monetary authorities stand ready to maintain and, if need be, increase liquidity in the financial system. The Fed will continue to hold off on raising interest rates, perhaps for the remainder of the year.
With no real way to assess the likelihood of the U.K. leaving the EU, from a risk management perspective we felt that it was prudent to tactically reduce all direct exposure to European stocks. The change was communicated, and effective, last week. We are now significantly underweight our strategic targets for international, developed market stocks and underweight risk assets in general. The proceeds of the sale remain invested in cash as we further assess the ramifications of this historic event and look for opportunities in risk-based assets.
Andrew C. Zimmerman - Chief Investment Strategic, DT Investment Partners
Note: DT Investment Partners’ commentary discusses general developments, financial events in the news and broad investment principles. It is provided for information purposes only. The material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Investments in various asset classes entail different investment risks. For example, small cap equities tend to be more volatile than large or mid-cap equities. International equities and emerging markets have exposure to currency fluctuations, foreign taxes, political instability and the possibility for illiquid markets. Fixed income investments involve interest rate and credit risks among others. Real estate investing includes risks such as declines in value of real estate, changing economic conditions, tax laws or property taxes. Commodities’ investing is highly volatile and subject to changing economic conditions and the vagaries of speculators among other risks. Further, diversification and strategic or tactical allocation do not assure profit or protect against loss in declining markets. Index performance returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index. Past performance does not guarantee future results.