Markets Brace for Rocky Friday After UK Votes to Exit EuroZone


Defying consensus forecasts, UK citizens voted 52% to "Leave" vs 48% to "Remain" with a margin of 1.3 million out of 33.5 million votes cast.  Urban voters favored "Remain" by 60/40, but rural voters voted substantially in the other direction.   White collar "info-workers" have generally benefited from UK integration into the European Union, while blue collar, less educated and older Britons generally faired worse.  Here is the distribution of votes across Great Britain, Scotland, Wales and Northern Ireland.  Labor party voters favored "Remain," Conservative party voters favored "Leave."

World markets trended higher over the last two months on the expectation that the UK would remain in the EU.  This morning, we're seeing a sharp, unpleasant reversal in markets overseas and in US stock market futures:

  • British pound down 7.9%
  • Euro down 2.9%
  • UK FTSE down 4.0%
  • French CAC 40 down 8.5%
  • German DAX down 7.0%
  • Japan Nikkei down 7.9%
  • US S&P 500 futures down 3.9%

David Cameron, prime minister of the UK, resigned, saying, "I was absolutely clear about my belief that Britain is stronger, safer and better off inside the European Union, and I made clear the referendum was about this and this alone - not the future of any single politician, including myself.

But the British people have made a very clear decision to take a different path, and as such I think the country requires fresh leadership to take it in this direction.

I will do everything I can as prime minister to steady the ship over the coming weeks and months, but I do not think it would be right for me to try to be the captain that steers our country to its next destination."

Practically speaking, Cameron will remain prime minister through October.  Boris Johnson, former mayor of London and current member of Parliament is the odd's on favorite to succeed.  The selection of a new prime minster is not the result of a general election by British voters.  Instead, one or more candidates are nominated by current Members of Parliament to a Conservative Party selection committee.  If only one nominee passes the selection committee, he or she wins by default.  If multiple nominees, there could be a series of ballots distributed to party members only with the lowest ranked candidate of each ballot eliminated until one candidate gets a majority.

The new prime minister invokes Article 50 of the "Treaty of Lisbon."

  1. Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements.
  2. A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. That agreement shall be negotiated in accordance with Article 218(3) of the Treaty on the Functioning of the European Union. It shall be concluded on behalf of the Union by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament.
  3. The Treaties shall cease to apply to the State in question from the date of entry into force of the withdrawal agreement or, failing that, two years after the notification referred to in paragraph 2, unless the European Council, in agreement with the Member State concerned, unanimously decides to extend this period.

Once Article 50 is invoked, the United Kingdom has two years to replace general EU treaties regarding, trade, taxation, defense, immigration and financial regulation with specific treaties with each of the remaining 27 EU members.  The reason why financial markets are reacting so badly to this vote is because the economic costs of going one-on-one with the rest of Europe are high.  UK GDP is expected to grow more slowly as UK exporters will have a harder time accessing European markets.

If Brexit is like poking yourself in the eye, why did British voters favor "Leave?"  The same dynamics we have seen in the US where globalization and immigration favors the educated elites at the expense of less educated industrial workers drove the decision in the UK.

What is the learning for the United States?  The Trump and Sanders campaigns attracted millions of US voters who are "mad as hell" about their economic prospects and want change - any change!  Clinton represents the status quo.  As the "establishment" candidates, she struggled to prevail over Sanders and will be challenged by Trump.  We are sending out an analysis of the US Presidential Election next week.

We are not making any immediate changes in our portfolios as a result of this vote.  The S&P 500 as of Thursday night was just 0.82% below the record high set 13 months ago.  If stocks close down 4% today (possible but more likely down 2%), stock levels will simply revert to levels seen two months ago.  Fed policy will likely remain on hold. 

The one good thing that might come out of Brexit is an incentive among remaining members to address structural barriers to growth, which keeps Europe in a state of permanent recession.  Otherwise, the EU may see a domino effect as other countries decide to exit.  Politicians in Holland, France, Italy and Denmark already called for referendums in their own countries.