After 43 years of membership, the UK electorate has voted to leave the European Union.
What is the European Union?
In order to truly understand the implications that this will have on the economy of the UK, Europe, and the rest of the world, it is important to first understand what the European Union is and why it is exists. The purpose of the European Union is to allow free trade between 28 member countries in Europe. It operates like the economy of one large country. If it’s economy is calculated as a single economy, it is considered to be the largest economy in the world.
The Eurozone is comprised of nineteen of the 28 member states of the European Union, which are bound by their official currency, the Euro. The UK is not part of the Eurozone, and has its own currency, the Pound.
Twenty-two of the member states belong to the Schengen Area, which abolished passport border control between these countries. Of these member states, the United Kingdom has never been a part of the Schengen Area.
In conclusion, the United Kingdom departing from the European Union will not change their currency, or their border patrols; it will only change their trade agreements.
What Does This Mean For The Economy?
Nothing has changed in the UK yet, and will take a minimum of two years to be put into effect. This historic decision opens up the prospect of multi-year negotiations with the European Union on how the separation will occur. Furthermore, the UK will then need to negotiate new terms for a trading relationship with the European Union in a post-Brexit world.
The biggest problem with the UK exit is uncertainty in world markets. The UK is the first member to leave the European Union, so there is no model to rely on. Markets react negatively to uncertainty. It is entirely possible that the UK will negotiate new and strong trading agreements with the European Union, and the rest of the world, but until those 52 new trade agreements are put into place, there will be great fear in the UK economy.
Other implications include a reduction in immigration. For voters, this may have been the reasoning for voting for a Brexit, but less immigration will lead to a shortage of service workers and higher UK labor costs, all leading to reduced foreign investment. Furthermore, Nicola Sturgeon, the first minister of Scotland, said it was “democratically unacceptable” that Scotland faced the prospect of being taken out of the EU against its will, giving more momentum to a Scottish referendum.
What Is An Investor To Do?
Chill out and stay the course. We have been through worse, and investors that stayed always recovered. One month after the 39% drop in the stock market due to the collapse of Lehman Brothers, the markets recovered by 18%. The September 11th terror attacks caused an 11.6% drop, and had come back by 11.3% one month later.
What matters most is how you react to a crisis, and in the game of long term investing. Historically, market rebounds outlast declines.
Since 1949, there have been 13 down markets, lasting an average of 14 months each, and declining a total of 24.6% before recovering. In this same time period, there have been 14 up markets, lasting an average of 44 months, and growing an average of 117.3%.
A UK exit from the EU is scary and leads us to unchartered territory. The implications are massive. The UK and world markets are likely headed for a rough, volatile market ahead. Accept this reality and sit tight. If you are invested in great companies, you will come out on top. Stop looking at your account and trust that markets are efficient. Even in the worst of times, we have found our way back.