Brexit: Investment Strategies from the Ashes

Two days before the historic vote, the Daily Mail backed Brexit, Britain’s EXIT from the European Union. It was not until then did I consider the actual possibility of a vote to leave. The referendum, the question presented to the general population for a vote was, “Should the United Kingdom remain a member of the European Union or leave the European Union?” In my mind, the answer was simply, “Remain.” Until Thursday night, it seemed a majority of Brits had the same answer as I did. When the results poured in, one of us got it wrong.

“It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong.” Stanley Druckenmiller

On the evening of Thursday, June 23, 2016, the world learned the United Kingdom voted, 52%-48%, to leave the European Union. Chaos ensued the next day in the world’s financial markets. The Nikkei 225, the Tokyo Stock Exchange index, ushered in its biggest decline since 2000, dropping almost 8 percent. The DAX, the German stock market index, closely followed with a drop of 7 percent. In the United States, the Dow Jones Industrial Average fell by 600 points (3.39%), its biggest loss in 10 months. In a strange turn of events, the U.K. market over performed, closing up 2%. However, the pound, the U.K.’s currency, fell to a 31 year low, down 10%. The Financial Times reported that the Global markets took a two trillion dollar Brexit hit. In short, the world’s markets tell a compelling story, the U.K. got it wrong and will pay severely.

“If you’ve got money, you vote in. If you haven’t got money, you vote out.”

In the days before the vote, The Guardian described Brexit as “a kind of misshapen class war.” Although class disparities and irrational xenophobia were the proximate causes of Brexit; the stage for Brexit was set twenty-four years ago in the Treaty, which created the European Union (“E.U.”).

One of the five aims of the E.U. was to establish “an economic and monetary union” with the ultimate goal of creating a central currency. Not eager to lose the pound, the U.K. conditioned its membership in the E.U. on an “opt-out” provision. This clause enabled the U.K. to participate in the E.U. without being mandated to join the currency. It was not a surprise when the U.K. decided not to opt in. Since the E.U.’s inception, the U.K. has taken an a la carte method to adopting its rules and regulations while still enjoying all of its benefits including increased investment in UK firms and access to a single market of 500 million people.

Look no further than the pocket of an average Brit for another, major contributing factor to the Brexit vote. While the majority of the E.U. member countries use the Euro, the U.K. was the largest non-participating member. Shared currency would have provided an actual identity between the U.K. and other member countries and might have made some voters consider how leaving would seriously affect their pocket. Now the country is headed into a recession. Those who championed Brexit will also bear the brunt of its burden. The average voter did not seem to understand, or appreciate, the implications of leaving the E.U. and now are poorer for it.

Where are the investment opportunities?

Brexit fueled a domino effect sell-off in the world’s financial markets; first Japan, then Germany, and finally in the US. In the second trading day after Brexit, the markets continued to slide as the world’s economic fate was still very uncertain.

Equities (Stock)

   Considering Warren Buffet’s advice, “buy when everyone else is selling,” now is a good time to buy. Regarding what to buy, Bank of America’s Chief Investment Officer, Chris Hyzy, suggested that investors should diversify into “higher-quality investments” and look to long-term investment growth strategies. Investors have been using that strategy as the U.S. market posted losses for the second day as they sold off “risky” holdings. Considering the geopolitical landscape, it seems fitting that U.S. and British banks have posted the biggest losses. For guidance on picking stocks, see my blog post, Three Steps to Picking Your First Stock.

Currency

In times of economic turmoil, many investors flock to “safe” assets such as the Japanese yen and gold. However, a strong yen is problematic for both Japanese companies and the Japanese economy. A strong yen makes it expensive for global companies to do business with Japanese companies making it difficult to spur the Japan’s economic growth. Tony Roth, CIO of Wilmington Trust, observed, “[i]f the yen does not weaken, the Japanese economy is going to get destroyed.” To counteract this, the Bank of Japan will sell off yen to lower the price. On the other hand, the pound will continue its unassisted downward movement as the U.K. heads into a recession. Between the two currencies, I would strongly consider a short position in the Yen.  Primer on the Forex Market.