How Investors Should Think About The Brexit Vote

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On June 23rd, British voters will decide whether their country should remain a member of the European Union. A vote in favor of leaving the EU - commonly called "Brexit" - would alter European economics and politics. It would also affect investors, although the exact implications of Brexit are shrouded in uncertainty.

The United Kingdom is the world's fifth-largest economy and the second-biggest net contributor to the EU budget, so a divorce from the EU would certainly reverberate throughout the European economy and global financial markets. Yet since no country has left the EU before (and the EU is fairly unique in terms of its economic heft as a multinational political body), there's no exact precedent that could help predict the economic implications of a Brexit vote. The novelty of the situation has allowed both sides of the debate to claim that their position would lead to better results for the British economy.

Most evidence, however, suggests that Brexit would be a net negative for the UK and the global economies, at least in the short term. The UK would have to negotiate new trade deals with the EU and countries around the world. Many companies would likely move jobs - and in some cases their whole firms - out of the UK so they could more easily do business internationally. A report by the British government projected that a vote for Brexit would lead to a year-long recession.

Financial markets could be further affected by prolonged uncertainty created by a vote for Brexit. It's unclear how long it would take for the UK to actually leave the EU and how long it would take to negotiate trade deals. A vote for Brexit would likely lead to the resignation of Prime Minister David Cameron, creating additional political uncertainty. And Brexit could prompt Scotland to break away from the UK to become an independent country, leading to another round of economic upheaval.

For US investors watching the Brexit drama unfold from a distance, there are a couple key points to keep in mind. While some of the fallout from a Brexit vote would be felt in financial markets around the globe, much of it would likely be concentrated in the UK itself. Some potential effects of Brexit, such as companies shifting their operations to continental Europe, could even provide a small economic boost to other countries. Having diversified exposure to countries around Europe and throughout the world could therefore help moderate the potential negative impact of a Brexit vote on British stocks.

It's also important for investors thinking about how the vote will affect their portfolio to note that some probability of either outcome has already been "priced in" to financial markets. Polls indicate the vote will likely be close, with polling averages suggesting that the pro-Brexit side has gained ground recently and is currently only slightly behind the "remain" side. Yet betting odds suggest that the likelihood of the UK voting to remain in the EU is still over 75%. These numbers will continue to bounce around until the vote actually occurs, but the betting odds suggest that markets would respond much more dramatically to a vote for Brexit than a vote for the UK to remain in the EU.