Last Thursday, June 23, citizens of the United Kingdom voted to leave the European Union. On Friday, June 24, equity markets worldwide lost over $2 trillion dollars with percentage declines outside of Great Britain generally exceeding those on the London market in percentage terms.
While there has been much speculation leading up to and since the vote, many of the longer-term implications of the referendum remain unclear, as negotiations on the terms of a UK exit are just beginning.
Porter White & Company and its affiliates have more than 35 years of experience advising portfolios, including during periods of uncertainty and heightened volatility. We monitor market events very closely and consider the implications of new information as it comes to light. We are paying close attention to market mechanisms and they appear to be functioning well. Our investment philosophy and process have withstood many trying times and we remain committed to our core principles which include broad diversification among the free markets of the world.
We urge caution in allowing market movements to impact long-term asset allocation. Long-term investors recognize that risks and uncertainty are ever present in markets. A drop in prices is generally due to lower expectations of cash flows, higher levels of risk in realizing the cash flows, or both. In some cases, a drop is also due to investors demanding liquidity. In the current situation, some investors may expect lower cash flows due to possible decrease in trade, a decrease in consumer activity based on uncertainty, or disruption in business activity during the transition. On the other hand, the shock of Brexit may lead to less bureaucracy in the governance of the European Union, greater economic freedom, and higher incomes and cash flows. It is too soon to tell.
Higher levels of risk (as measured by a discount rate) may be driven by the uncertain changes in the economic landscape and regulations and unforeseen spill-over effects caused Brexit. We have seen markets increase discount rates in times of uncertainty before, resulting in lower prices and increased expected returns. However, it is difficult to know when good outcomes will materialize in the future. By attempting to time the right moment to invest or redeem, one risks not enjoying the potential benefits of such materializations. Many of those who exit the markets miss the recoveries. What we have often seen in the past is that investors who remained in well-diversified portfolios were rewarded over time.
The UK will have up to two years to negotiate a withdrawal, during which time it remains subject to EU treaties and laws. Any potential operational changes depend on what path the UK and EU decide to take.
Diversification does not protect against loss in declining markets. Past performance is no guarantee of future results. Investing involves risk and the possible loss of principal. There is no guarantee any investment strategy will be successful.