Brexit: An Indirect Effect (OPINION)

It’s ironic. The United States celebrated its Independence Day with fireworks, barbecues and family reunions honoring the decision that was made on July 4, 1776, declaring our independence from the British Empire.

Today, 240 years later, the United Kingdom is faced with a similar situation. The people of the United Kingdom have voted for independence and to secede from the 28 nations that make up the European Union. 

As the markets digest the implications of “Brexit,” there will be a trickledown effect on the world. In Northwest Arkansas’ largest industries — consumer staples/retail, transportation, the food industry and banking and finance — the exposure to Brexit is minimal. However, the indirect implications will become more important in the coming months.

According to Raymond James chief economist Scott Brown, “the direct impact of ‘Brexit’ on the U.S. economy may be small. The U.K. accounts for a very small portion of U.S. exports and imports.”
American companies generate about 70 percent of their revenues inside the U.S.  In 2015, 3.7 percent of U.S. exports and less than 2.6 percent of imports can be attributed to the U.K.  If there is a recession in the U.K., Brown believes that a weaker currency and lower interest rates may soften the impact. 

Nick Lacy, chief portfolio strategist of Raymond James, says, “In the near term, we expect elevated volatility and a rally in high-quality investments, such as investment grade bonds and dividend paying stocks.” 

Raymond James transportation analyst Art Hartfield says, “While in general the U.S. transportation complex is largely ‘U.S.-centric,’ we stress that the system is influenced by global trade, global economic health and the impacts on import/export trends from currency fluctuations.”  

The recent flight to safety strengthens the dollar which is likely to remain a restraint for U.S. exporters, because a stronger dollar makes our products more expensive overseas.

Credit Suisse analyst Robert Moskow says in regards to the food industry, U.S. packaged food stocks are expected to hold up better than the broader market due to their inherent stable nature. He goes on to say, “we expect companies with the highest Euro exposure to underperform … these companies will have to cope with the probability of a recession in the U.K., the immediate prospects of higher raw material cost due to transaction currency exposure, and higher tariffs across Europe … expect these companies to pass through these higher costs to the consumer through pricing.” 

In the consumer staples/retail sector, recent data suggests a pickup in U.S economic growth in the second quarter. “Spending has picked up,” Brown says. “Aggregate real income has posted strong gains and should help to support spending growth in the near term.”  

As for the financial sector, Raymond James analyst David Long says domestic banks with the “greatest sensitivity toward higher rates have generally been the worst performers as the yield curve has compressed and the likelihood for any rate hikes this year have faded. Regardless of future Fed action, we would anticipate downward pressure on … earnings, if the Brexit uncertainty persists.”  

Brexit would deepen the decline in global interest rates, and we would expect U.S. interest rates to decline further.

Volatility is likely to remain for the short term as long as uncertainty prevails.  It is not evident how Brexit will affect earnings and economic growth in the future, but we know that Brexit has created new risks and new opportunities.  

In July, the Raymond James investment strategy committee shifted its tactical asset allocation weightings by recommending reducing exposure to the equity markets and increasing fixed income exposure, relative to Raymond James’ longer-term strategic asset allocation models. 

From Britain’s perspective, things will clearly change, but this is a shock, not necessarily a crisis. Perhaps the British vote to exit reflects a belief that the benefit of independence from the E.U. outweighs the financial consequences. 
More than any period in recent history, it is vitally important to know what you own and why you own it, as it pertains to your investments. 

Coleman Ward, senior vice president of wealth management, is the Northwest Arkansas complex manager for Raymond James & Associates Inc. in Fayetteville.