Advisors and institutional investors continue to ask me what the implications of Brexit will be. My answer: Don’t think of it as a crisis—a massive collapse followed by a sharp recovery, which is how the market has reacted—but a slow and steady grind with some notable implications.
Limited New Investment
First, much investment in the United Kingdom will be foregone as a result of leaving the European Union (EU). I’m not saying a host of large companies will suddenly pack up and move elsewhere tomorrow; that’s a costly decision, and one made with much consideration over time. But companies won’t likely expand in the United Kingdom; they’ll expand elsewhere.
Consider a mid-size company looking for a supplier in Europe and choosing from a short list of companies—one in Spain, one in Sweden, one in Austria, and one in the United Kingdom. The U.K. supplier could be every bit as good as some of the other others on the list, but why would you choose it for a long-term partnership? The uncertainty of how Brexit will impact the supplier presents a level of risk that doesn’t exist with the other suppliers.
No Rebound For The Pound
Second, while the U.K. equity market might continue to rebound, the currency likely will not. The pound is significantly lower today than it was on the eve of Brexit—approximately $1.30 now vs. $1.45 to $1.50 before.
Now, this is theoretically good for U.K. businesses that sell products overseas. A lower pound makes exports cheaper, so U.K. exporters should be more competitive in global markets. That’s why many proponents of Brexit cited the potential competitive gains that could come from it.
But there will likely be no long-term competitive gains. Why? Because 50% of U.K. exports go to Europe, and if there’s weaker final demand from Europe, it doesn’t matter how cheap or how expensive an item is. When 50% of your total pie suddenly decelerates, it has an adverse impact.
This was tested in the United Kingdom in 2009, when the pound fell in the aftermath of the global financial crisis. Everyone expected an export move, but it didn’t happen. It’s also been tested across Europe; in fact, it’s why European countries decided to abandon their individual currencies to join together in the euro.
Still Too Early To Tell