Market Commentary: Long-Term Questions Spawned by Brexit are Even More Unsettling Than Market Turmoil

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After several months of relative calm, on June 24th, the financial markets sent a sharp reminder that we’re still in a stormy age of global uncertainty and interdependence. The surprise result of Britain’s vote to leave the European Union, or Brexit, triggered panic on Wall Street and around the world. The reaction wasn’t surprising, nor was the market’s fairly rapid recovery. Yet, despite that rebound, economists and analysts aren’t exactly breathing a sigh of relief.* That’s because Britain’s move and the market’s reaction to it have some long-term implications that are deeply disturbing. Investors, especially those within ten years of retirement, need to be aware of what could come next.

Naturally, no one can predict for certain what’s going to happen, largely because the entire European Union is an unprecedented experiment in global economics. The potential of a major player pulling out of the union wasn’t really considered or prepared for when the EU was created 23 years ago. Imagine if Texas suddenly voted to leave the United States. Could it survive without us? Would its decision weaken the other 49 states – possibly to the extent that others began to follow Texas’s lead?

That’s really the scenario that is most unsettling when considering the potential ramifications of England’s move. As many were quick to point out that the EU was clearly much stronger with England in the fold and London as a regional financial capital**.  The departure has not only triggered a lot of chaos and uncertainty for England itself, but for countries with weaker economies that depend on the strength of the EU as a whole.

Devastating Effects 

Think about other relatively stable economies in the union like Germany or some of the Scandinavian countries. What if somewhere down the road, they decided to follow England’s lead? Now think about EU economies like those of Greece, Italy, Spain, and Portugal, which are not only less stable, but are actually in, or on the brink of, crises. Bear in mind that Greece was bailed out of economic default only because the EU got together and bailed it out.

But with England now gone, the union as a whole is already weaker, and if more strong economies were to pull out, there is concern that the European Union, overall, would no longer be strong enough to help weaker countries in danger of defaulting. And if the EU can’t get involved, it’s unlikely the U.S. would come to the rescue. In the end, it could create a situation where the only option would be to allow the relatively weaker countries to fail. Needless to say, with the global financial markets today being so interdependent, the cascading effects of a situation like that could be devastating worldwide.

As regular readers know, we believe our current long-term secular bear market cycle still has several years to go and that a third major sustained market drop – like those we saw from 2000 to 2003 and from 2007 to 2009 – is overdue. We’ve pointed out that if this current cycle were already over and the market permanently recovered (as many “Wall Street cheerleaders” like to pretend), it would signify several world records, including shortest secular bear cycle in history and first to end with fewer than three major drops. That seems extremely unlikely.

On the other hand, with so many unprecedented factors impacting the global economy, we believe conditions might be right for what could turn out to be the longest secular bear market cycle in history. Think about it. If the entire EU were to steadily collapse in the coming years, how many more years might it take for the financial markets to recover?

Another Reminder

Again, no one can predict what’s going to happen. And, as mentioned, the stock market rebounded from the Brexit turmoil within a week, indicating its belief that England’s departure by itself is, ultimately, not the end of the world. The bond market – which is said to be “smarter” than the stock market – had already given that indication by virtue of the fact that the decrease in bond values was minimal after the vote.

Nevertheless, the panic over Brexit, which erased an estimated $3 trillion in market wealth in two days**, was just another scary reminder of how quickly and abruptly fortunes can shift in the age of global economic uncertainty. We saw a similar scenario last August when worries over China’s economy triggered a record four day stock market “flash crash.” With the EU now fractured and the stock market overdue for another prolonged steep plunge, investors close to retirement need to ask themselves how many more times they are willing to roll the dice on these scary reminders.

*“CEO Offers Some Words of Wisdom as Uncertainty Spikes and Market Volatility Explodes, Yahoo Finance, July 1, 2016
**“Why the Timing of this Brexit Mess Couldn’t Be Worse for the World Economy,” Yahoo Finance, June 26, 2016