Yesterday the UK voted to leave the European Union. This decision was a surprise to the global markets as many investors had believed that the chance of this occurring was very low. In reality, all of the major polls were suggesting that the decision was actually a 50/50 decision and nearly impossible to call. Effects on the major global economic participants from UK’s exit from the EU is difficult to predict as we are in uncharted territory. The initial analysis in the short-term suggests a weaker economic environment for both the UK as well as the rest of Europe as trade disruptions influence both demand as well as currencies. Our view from an economic perspective is that the impacts from this decision will take much longer to develop. The complete withdrawal can be up to two years away and there is plenty of time to soften the negative impacts that the decision may imply. Time is a great healer and both the UK and European Union will have time to work through the issues of the exit before they begin to have a major lasting impact.
From a market perspective, we expect short-term market weakness with increased volatility. Much of the performance that has been given back today has been a positive performance that was gained over the past week as investors believed that Brexit was unlikely. Also, along with the unknown, we believe the markets are trying to handicap the potential of other countries trying to leave the EU. Even though this is a possibility, we place low odds on this happening because unlike the UK, the rest of the EU is tied to the Euro which would significantly complicate any other countries ability to exit the EU.
Given the announcement, many may be asking, "what are we doing in the portfolios given the decision?" As value investors, we always look at market disruptions as opportunities to find new investment opportunities. Leading into this event, our portfolios were constructed in a way that was agnostic to its outcome. We analyze your portfolio every day and none of these changes take place because of an event like this. Although we could not predict the outcome of this vote with certainty, we were careful not to participate in any large investments that would be impacted by either side of the decision. Heading into the Brexit vote, our portfolios had several investments that we felt could protect returns if in fact the Brexit vote occurred:
Underweight Equities – We have been saying for some time that equity markets were slightly overvalued. Because of this, we have a lower than normal weighting in stocks with dry powder that can be used to take advantage of a market decline.
Underweight Europe – Anticipating that something like this may happen, we are only half weighted to European equities. Also, the European fund that we own is hedged to the U.S. dollar. Because of this and the strengthening of the U.S. dollar vs the Euro, this investment should perform better than its peers.
Treasury Bonds – Treasury bonds have been beneficiaries of the “flight to quality” that occurs during times of market distress. For that reason, we see them as an integral part of our investment portfolios.
Gold – Gold has also proven to be a beneficiary of the “flight to quality” and should provide the portfolio with volatility reducing qualities, especially during black swan events.
Lower beta /higher quality stocks – Our style leads us to own lower beta/ higher quality stocks in the portfolios. These companies generally have higher growth rates, better profitability, higher returns and better balance sheets than the market as a whole. These types of companies should hold up better than the market in times of turmoil.
Tactical Mutual Funds - These funds have the ability to own both long and short positions. The short positions allow these funds to potentially generate positive returns, even in large market declines.
As we did in the January market dislocation, we will continue to be diligent in the portfolios over the coming weeks by analyzing new data, stress testing the portfolio and taking advantage of new opportunities that this market disruption provides. As always, thank you for all of your support.
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by FAI Wealth Management), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from FAI Wealth Management. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. FAI Wealth Management is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of FAI Wealth Management's current written disclosure statement discussing our advisory services and fees is available for review upon request.