Investment Opportunities Abound after Brexit Vote

Delivering on an earlier campaign promise to let the people decide the fate of Great Britain and the European Union (EU), current Prime Minister David Cameron is bringing the referendum to a vote today. The stakes are significant and could have both short and long term implications on worldwide stock markets as well as on the economies of Great Britain and the eurozone.

Some have even suggested that investors are now more focused on the implications of the Brexit vote than they are on what the Federal Reserve does with interest rates this summer. Before we get into the potential implications to investors of a decision to leave the EU (aka, Brexit) or a decision to not leave the EU, we believe it would be beneficial to provide a historical context to the debate and highlight some key areas that could be impacted.

Great Britain has long been a member of EU, but notably absent from the eurozone, the group of nations that elect to use the common euro currency, preferring to still use its native British pound (GBP). Nine other countries in the 28-member EU (i.e., Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Lithuania, Poland, Romania and Sweden) also do not use the euro as their currency.

There have been many vocal opponents within Great Britain questioning the need to remain within the EU going forward, citing concerns over trade agreements, immigration policies and regulation costs. Overall, some believe that they are “not getting out as much as they are putting in” with respect to EU membership and that there could be better potential uses of this funding within their own borders and an improved economic outlook if they could have more control of their own destiny. Others in Great Britain believe that it should remain within the EU and are fearful of how a Brexit would impact its exports and standing within Europe and the rest of the world.

It’s all about trade and economic growth

From an investment viewpoint, trade and economic growth are at the heart of the potential implications of this referendum vote in England. According to BBC.com, approximately 28% of what is produced in Great Britain is sold abroad.

Interestingly, while about half of this trade in the United Kingdom (UK) is conducted with the EU, England imports more overall than it exports to the EU. Hence EU country members need Great Britain as much (and perhaps more) as Great Britain needs the EU from a trading relations standpoint. Additionally, the cost of adhering to EU regulations are considerable for Great Britain, but were they to go it alone, there would still be some associated costs for them to access EU markets.

Heading into today’s vote, overall sentiment still seems to be pointing toward them staying put, although it is arguably too close to call. Based on all of the reports that we have read at this time, we still believe that the referendum will likely return a “No” vote.

What happens if the Brexit vote is “Yes”

It is important to recognize that even if the referendum results in a “Yes” vote to leave the EU, actual implementation of such a decision would not take place until 2018, given the two-year requirement of such a notification in accordance with EU policy.

Such a “Yes” vote would likely result in short-term volatility due to the uncertainty of how this will play out within the global capital markets and stoke fears of possible contagion where other member countries may considering leaving the EU as well. If that does occur, this could ultimately lead to the longer term demise of the EU and the dismantling of the common euro currency.
While such an outcome would be unprecedented and its market impact within the region unknown, it could prove beneficial to portfolio managers who would then be able to more easily pinpoint particular economies and currencies within the eurozone for investment that they believe offer the greatest growth potential as opposed to weighing out the ramifications of one governing body and one common currency across multiple countries and cultures.

Over the shorter term, it could also weaken both the British pound and euro currencies and further strengthen the U.S. dollar. A strengthening US dollar could impact large US multinational companies that derive a significant portion of their revenues overseas. Potential investment strategies for such an event could include investing in exchange-traded funds (ETFs) that benefit from a strong US dollar or US mid- and small-cap companies that would not be as impacted by weaker exports and US dollar strengthening.

There are investment opportunities either way

“Yes” vote or “No” vote, this may also be an opportunity for investors who believe that there is more growth potential overseas than domestically at this stage of this market cycle to allocate to international markets that they find most attractive. For example, if investors believe that Great Britain stocks will rally after the referendum and that the UK economy will continue to improve, there are seven current ETFs according to ETF Database, some that incorporate currency hedges, which are focused on Great Britain.

On the other hand, if investors believe that European markets as a whole will rally after the referendum and that the eurozone will continue to slowly improve, there are 94 current ETFs, according to ETF Database once again, that are focused on developed Europe.

In our view, it is highly likely that US stocks, United Kingdom stocks and European stocks will all rally to a degree over the short term if the referendum returns a “No” vote and Great Britain decides to stay as a member of the EU, but not as much as some may anticipate, given that this potential outcome is at least partially priced into current market valuations.
Conversely, if a “Yes” vote is returned, these markets may suffer a setback over the short term. This will also likely lead to future market volatility in the days and weeks that follow given the uncertainty over what may, or may not, happen next.

Disclosure: The overview above is for informational purposes and is not an offer to sell or a solicitation of an offer to buy any of the securities listed. Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with the themes discussed above.

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