The Reaction of the European Bourses

On June 14^th, the FTSE closed at 5923.50.  On June 15^th, the world’s major bourses began their run-up in anticipation that “remain” would win in the U.K. referendum.  The FTSE rose 7% from its June 14^th level until June 23^rd (to 6338.10), the day of the referendum.  The day after the referendum, when the “shock” of “exit” was highest, the FTSE fell 3.1% to 6138.70, and on Monday, it fell further to 5982.20.  Note, it was still not below its June 14^th level.  Today, June 28^th, the FTSE closed at 6140.39, still 3.7% higher than it was on June 14^th.  This should tell us that the U.K. market participants don’t see that the Brexit vote will have an immediate economic impact on the U.K.’s economy.  [Similarly, in Germany, the DAX was 9519.20 on June 14^th, and closed at 9447.28 today, June 28^th, a loss of less than 1%.]

Parsing the Results

• The following table shows the results of the Brexit vote by age cohort:

Observation:  The older generations who turned out and voted to leave won’t bear any of the economic burdens, as they don’t have that long to live with the consequences.  The younger folks should learn about the importance of voting from this result.

• If you thought that the vote would clear up the uncertainty one way or the other, you were wrong:
  • The referendum is non-binding and there is no assurance that any official body will act on it;
  • The vast majority of Parliament are pro-E.U. and in order to “leave,” Parliament has to invoke Article 50 of the Lisbon Treaty which starts a 2 year clock ticking; there is no certainty that Parliament will do this;
  • P.M. David Cameron says he will resign in September or October and a new government will be formed.  He said his government will not invoke Article 50.  So nothing happens until a new government is formed and there is no guarantee that the Parliament will invoke Article 50 anytime soon (some say not until 2018; maybe not at all);
  • In the immediate aftermath of the referendum, there was an on-line petition for another such referendum (buyers regret?) which apparently had several million on-line signatures
  • At this time, it is not a complete certainty that the U.K. will actually leave.  There is still a slim possibility that this becomes a wake-up call to the E.U. to revamp its Brussels’ bureaucracy.  The biggest issues in the referendum were:
    • Immigration
    • Business Rules and Regs

(Sound familiar?)  Perhaps it is possible that Brussels allows the U.K. to have some say in the immigration issues (although I would put low odds on this idea).

• So, it is entirely possible that after all is said and done, the U.K. actually stays

The Aftermath of Brexit

• There is worldwide sentiment that is anti-global and anti-free trade; this most likely has been brought on by the intrusiveness of large governments with their bureaucracies, cronyism, corruption, and the use of power by unelected bureaucrats to write rules and regs that have the force of law;
• The initial political fear is that Brexit is just the beginning of the unwinding of the E.U. and other political instability;
  • Scotland’s vote was more than 60% to “remain” and is now likely to have another referendum to determine if it wants to exit the U.K. and remain in the E.U. – that ought to be interesting;
  • N. Ireland, still part of the U.K., has very close ties to Ireland (which is an independent country and a member of the E.U.).  Will a U.K. exit cause issues here?
  • Then there are those right and left wing factions in Spain, Italy, and elsewhere in Europe that will gain strength as a result of Brexit.  So, the E.U. is likely to play hardball with the U.K. lest it encourage more exits if it makes it too easy

The Economics of Brexit

• There is the uncertainty that has now arisen as to what the business environment will be, and that may cause business to hesitate to invest.  This is a theoretical argument and is almost impossible to measure.  At worst, it would cause some slowdown in economic growth.  But the calls for immediate and severe recession are purely emotional and illogical;
• A long-term view regarding business rules and regs is also speculative at best.  The argument is that as part of the E.U., it is easier for business and labor to trade in any of the E.U. countries because they only have one set of rules (i.e., less red tape).  It should be pointed out that U.S. multinational companies have no trouble trading in the E.U. where the U.S. is not a member;
• Workers, too, currently have an E.U. passport and can live and work in any E.U. country without a lot of red tape.  Once again, the U.K. has not yet exited, and we can only speculate as to what the rules will be for U.K. workers in the E.U.
• Some have commented that London would lose its status as a financial capital – this is not going to happen; there is too much investment already in London, and if there is one thing that banks and financial institutions know how to do, it is to navigate through the tangle and morass of rules and regs.

Conclusions

• The “exit” vote was a shock, and markets always react to shocks;
• The FTSE never fell below its June 14^th level (prior to the run-up in anticipation of “remain”), and two weeks later (June 28^th) the FTSE is 3.7% higher, a healthy growth under any circumstances; the DAX, too, is only down 0.8% from its June 14^th level;
• By age cohort, the young overwhelmingly favor “remain.”  Too bad they didn’t turn out to vote for it;
• It is still uncertain whether and when the U.K. will actually “exit”
  • The referendum was non-binding’
  • The vast majority of members of Parliament are pro-E.U.
  • Who will invoke Article 50?
  • The E.U. could actually reform in an effort to keep the U.K. (low probability)
• There may be other political fallout
  • Scotland
  • N. Ireland
  • Other E.U. members
• The economics of the U.K. falling into recession as a result of Brexit are not compelling
  • The uncertainty argument regarding business investment is speculative and, at best, would reduce economic growth by a few tenths of a percentage point
  • The freedom of movement of the workforce and single set of business rules arguments:  these are valid, but this will not be reality until exit actually occurs.  In addition, we do not know what the final negotiations will be regarding these issues, nor will we for several years.  So, to impute an immediate economic reaction seems a little far fetched

Market Participants

• The immediate shock of the unexpected vote led to the expected volatility
• But the end result will take a really long time to play out; the actual impacts will not be obvious; and there are really only very small immediate economic consequences, if any
• In the near term, as expected, the markets overreacted; but because there are no specific indicators to follow, the market will soon lose sight of this as a day to day issue; when some Brexit related event actually occurs, the markets will focus for a short-time, then return to business as usual

Robert Barone, Ph.D.