David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with DaveDeborah Baic/The Globe and Mail
- The latest developments: How Brexit happened and what’s next
- Global markets shaken
The Brits voted for the Brexit by a margin of 52 per cent to 48 per cent, with a large turnout too (72 per cent).
To call this a shock is a bit of an understatement, but, in the end, the actual public opinion polls were spot-on for a change.
The markets in the past few days, as we suggested, had prematurely gone and fully priced in a "Bremain," which is accentuating the risk-off trade across the planet.
Prime Minister David Cameron is another casualty, announcing that he will step down in October.
Next in line is Article 50 being invoked and the exit negotiations beginning, which promises to be anything but smooth.
Moreover, there can be little doubt that Scotland calls for another referendum for secession from the U.K.
Of course, we have elections in Spain on June 26 and in France, Germany, and the Netherlands next year. At issue will be this wave of anti-establishment and anti-globalization sentiment and how it spreads.
The surveys over the past year indicate that disenchantment with the EU has transcended beyond just the U.K.
So we are in a period of limbo here, the odds of a U.K. recession have surged and this is a very big setback for Europe in general since it can be reasonably expected that business spending freezes up and consumers display their caution by boosting their savings rate.
This is, after all, as big a chunk of the global economy as the U.S.
While a negative shock to a global economy, which has already been on the receiving end of forecast downgrades of late, the impact in the U.S. and Canada is much more indirect and modest.
U.S. exports to the EU can dive 20 per cent and that alone would only have a half-point drag impact on U.S. real GDP growth.
No, this is not a Lehman moment — no bank is going down for the count over this. But the major impacts will be tertiary in nature or indirect, and could be significant.
For example, the tightening in financial conditions is likely to exert a greater effect than the direct impact through the trade channel.
This includes the U.S. dollar, because if it strengthens dramatically in this massive flight-to-safety backdrop. Attention will shift to the yuan and the elevated risks that we see a round of devaluation that in turn causes investors to start discounting the prospect of a global currency war.
This may be what the surge in the gold price is sniffing out right now and bears watching.
After all, the January panic in global markets was largely due to what was happening in the FX markets and, principally, the fears over the fallout from a weaker yuan.
This is an historic event and the markets are responding to the heightened uncertainty. Already, we may be seeing an overshoot in this dramatic move to shed risk.
Remember: we would not be seeing such a dramatic market move if investors had not become so complacent in the past few sessions and treated a "remain" vote as a fait accompli.
The market reaction is severe and swift but likely will prove overdone and a buying opportunity, especially in cheapened-up U.K. assets.
But it goes without saying that waiting for evidence that the dust settles first would be a prudent approach — but could come as early as in the coming week.
Markets have this nasty habit of shooting first and asking questions later. Cash will still be your friend in coming days or weeks but likely not much beyond that.
To reiterate, this is not an unmitigated disaster for the U.K.
Keep in mind that 22 European countries reside outside the EU.
But this is about elevated uncertainty about how existing institutional relationships change. And of course, an overhang in the coming year regarding the entire EU framework and how it will change.
It is this heightened uncertainty that will be the greatest obstacle for capital spending growth in the coming year, with spillover globally. But keep in mind that this is not about business insolvency or a financial event — it is about shifting politics.
So no need to go overboard with the negativity.
It can be reasonably expected that this shock causes global growth forecasts to be shaved further from already-low levels, and that is negative for commodities and resource-based currencies, except for precious metals.
Cyclical stocks, especially those hitched to global supply chains like large-cap exporters, will likely take the greatest hit.
The theme of "Safety and Income at a Reasonable Price and Yield at a Reasonable Price" is squarely back into the focus.
Flows to North America are likely to pick up, and perhaps more into Canadian assets since the U.S. is beset with political uncertainty of its own for the moment (the Brexit vote plays nicely into the Trump camp who was urging the Brits to leave).
Core sovereign bond markets will retain a bid and yields at the long-end are likely to drift even lower since this is a deflationary shock at a time when measured inflation rates were already very low practically everywhere.
This in turn keeps bond proxies in the stock market in play, like utilities, telecom services, and REITs.
In every market, the more locally focused the company is the better.
Regionally, because the U.K. has its own currency which is now depreciating sharply, we may well see British markets snap back earlier than most, and within the stock market those areas that have high foreign sales exposure to take advantage of the FX translation, a low beta to the market and low degree of cyclicality, coupled with high dividend yields and consistent payout ratios (Imperial Brands, with a total return of 18 per cent in the past year, comes to mind).
It probably serves as a good idea to remind investors to stick to their process, avoid the temptation to be overly active, and most importantly remember your long-term goals — volatility is your friend not your foe.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.