Political forces in the UK are already at work trying to find a way to nullify last week’s shattering Brexit vote. Millions, including contrite “Leave” supporters, have signed a petition asking for a new vote. It’s not impossible that more people will end up petitioning for a second referendum than actually cast ballots in the original vote. Some are also suggesting a second referendum could be loosely tied to a radical restructuring of the European Union. Markets responded favorably to the British mea culpa, but there are dangers ahead that cannot be so easily undone. The Brexit vote may have inadvertently uncovered weak spots in the global economy that were not previously apparent.
At this point it may not matter whether Britain stays in the EU or not. The uncertainty is already interfering with global commerce in ways that illustrate how fragile confidence can be on the world stage. Some of the aftereffects are limited to the UK, but many are washing up on EU shores. And while the Britain stumbling is survivable, the EU economy, by some measures the largest in the world, destabilizing or even collapsing would send apocalyptic shock waves, seriously end-of-the-world trauma, through the entire global economic system.
Dramatic Warning from the No-drama President
Even President Obama, not someone prone to feed panic, warned Wednesday that there could be a great deal of market instability ahead. The focus of the president’s comments also seems to be that the big risk isn’t from the UK as much as from instability in the EU itself. With British political leadership in chaos since Prime Minister David Cameron announced he would step down in September, a new wrinkle appeared when Brexit cheerleader, former London Mayor Boris Johnson announced Thursday he wasn’t running for the leadership job either.
The political chaos in Britain is matched only by the internal turmoil in the EU. Stung Eurozone leadership wants to push Britain to leave as soon as possible but it’s not clear who they might be talking to inside the British government to effect such a move. It’s also not clear how they could pressure Britain to move any faster.
For their part, EU leadership is doubling down, refusing to budge on the refugee crisis, the EU court system or the amount of money Britain pays into the multi-national union; insisting they won’t negotiate with the Brits. This because in many ways the Brexit vote was a no confidence vote on EU leadership. But at a time when Union leaders should be at their most conciliatory they have, once again, decided to remind everyone that, when it comes to the EU government, the problem is dictating the solution. The New York Times reports Dutch Prime Minister Mark Rutte, formerly one of Britain’s staunch allies, said, referring to the post-Brexit political and economic storms in the UK, “To everybody thinking of leaving the single market, this is what happens.”
Don’t Buy Into the Rally
U.S. stocks bounced back after two brutal days immediately following the Brexit vote. But even the most conservative analysts agree the current rally is only temporary. Ongoing uncertainty, combined with a lack of confidence in central banks, spells serious trouble for the future of equity markets, also sometimes (correctly) called “risk markets.”
Your Defensive Formation
The smart move for investors now is to use this possibly brief rally as an opportunity to develop a more defensive portfolio strategy. A shift to dividend and income stocks that can maintain earnings in a challenging economy for the money you want to keep in the stock market is a prudent precaution. Bond yields are going to get hammered in a flight to safety and cash is no longer a safe haven as central banks will be forced dump cash to banks in order to keep money moving into the economy.
What was once an emergency option for central banks has now become the norm, and those who don’t hedge the spending power of their cash by converting some of it to liquid hard assets like physical gold and silver, risk watching their protection evaporate. Economic security is going to be in short supply in the months ahead, so stock up now while you can.