The Brexit Surprise

When you least expect it, expect it. I seem to remember that line from a1970s sitcom. Perhaps it was an older brother promising revenge on a younger sibling? In any case, as it turns out, those cautionary words aptly describe the results of the Brexit referendum. Even in the days leading up to the United Kingdom’s historic Brexit vote, most experts gave an exit vote only a 25 percent chance of succeeding! And recall that Prime Minister David Cameron, who resigned in the aftermath of the vote, actually called for the referendum. Talk about a misread of your constituents! Therefore, it’s no surprise at all that the shocked markets reacted the way they did.

Reaction was swift and severe when the British people decided to end their country’s 43-year membership in the European Union (EU). London’s blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day. The British pound sterling is was down 14% against the Japanese yen and 10% against the U.S. dollar. Additionally, Germany’s DAX market lost more than 7%. And, in the U.S., the S&P 500 index fell 600 points.

Those commenting on Brexit also had extreme reactions. Alan Greenspan called the markets’ reaction the “worst period I can recall since I’ve been in public service” and predicted additional volatility in the weeks and months ahead. Other commenters were cavalier, noting the world will survive and the “British people will still eat fish and chips this weekend.” In my view, the market reacted to the fear felt by many. Emotions, in this case fear, often spark irrational decisions especially given the fact the vote does not guarantee an exit and will take a couple of years to implement.

More than anything, the power of fear to influence our decisions should prove a lesson for investors. An email I received from Dimensional Fund Advisors provides the rational reassurance I would offer all investors: “Dimensional Fund Advisors has nearly 35 years of experience managing portfolios, including during periods of uncertainty and heightened volatility. We monitor market events–including their impact on trading and trade settlement–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.”

One other interesting point to note is that the VIX Index, which is a gauge of market fear, hovered around 24-25 on Friday, June 24. Interestingly, that level measured the day after the Brexit referendum vote, was well below other points that we’ve experienced during the past year. Specifically, he VIX was above 50 in August 2015 and was above 24 during days in both January and February 2016. In other words, so much for Alan Greenspan’s analysis that markets are in in unprecedented territory!

I’ll reiterate what I have said so often — fearful (or greedy) investors often abandon their diversified investment strategy at the exact wrong time. The market rewards patience, reason and discipline. We’ll see more volatility in the coming weeks and months as new leadership in the U.K negotiates an exit from the EU. As always, maintaining proper diversification and a long-term market view will be your best strategy.

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