With the United Kingdom recently voting to leave the European Union, it seems like everybody is panicking and focusing on the negatives without even considering the positive implications of this decision. Without even knowing the implications, many hurried to sell off all their UK securities with the intention of leaving the UK and reallocating the capital in another market. Was that the right thing to do? Certainly not, in my opinion. It is inconsiderate of the long-term implications of Brexit, and what sense does it make in the first place to sell the cheap market to reallocate in an expensive one such as the US, which trades at more than 25 times its earnings.
Leave or Remain: a more complex question than the market realizes…
Throughout this article, you have to keep in mind that it is impossible to know at this point what the real exact short and long-term implications of Brexit for the UK will be. It is famous that economic forecasts are rarely right, and hence I will not give it a try.
I won't tell you if Brexit was a good or bad idea, as it is out of my circle of competences. What is clear to me is that the question whether it was a good or bad idea is not one that can be answered today. Anyone who pretends to know the answer and gives an opinion with great confidence is likely to have no idea what he is talking about. This question is much more complex than that and cannot be answered today. We will really know 5, 10 or 20 years from now if leaving the EU was the right call for the UK.
Despite the fact that nobody knows this answer, note that everybody is totally freaking out, and believe with great confidence that it was a terrible idea. This is especially true in Europe. I come from Finland and have gotten to live in many other European countries, including the UK, during last year, and what I see is that the media over here has been very one sided when covering Brexit and its implications. To a large extent, it is the fault of the media that people are getting so scared and confused over this event, and in my opinion, the story has been covered in a very negatively biased way. While it is clear that Brexit is likely to have negative effects on the economy in the short run, does anyone even consider the long-term picture anymore?
After all, the UK is the world's 5th largest economy and it is not going anywhere. With or without the EU, the UK's industry and economic power will remain strong in the long run. Many of the relationships that the UK has today will not be broken, they will just be reformulated or simply continue to exist. So the actual practical effects of Brexit are probably significantly less than what people are anticipating. The short-term negative effects of Brexit are not a function of structural issues in the economy, but the changing behavior of market participants. This "crisis-minded" behavior will, however, not remain permanently; it is only temporary and as it dissipates itself, the markets will start functioning normally again.
People tend to forget that not all countries in Europe are part of the EU. Good examples are Norway and Switzerland, which are doing just fine without being members. You could argue that they are actually doing much better than most other EU countries, and one reason explaining that is the higher flexibility that they enjoy in developing their own economic policies. Norway and Switzerland are both some of the richest countries on earth and not being part of the EU gives them a competitive advantage to a certain extent. If the benefits of being a member were that high, they would have joined the EU a long time ago.
I believe that the UK leaders will end up coming with a deal that will ultimately be quite similar to the current membership with the EU. The UK will just not "technically" be a member any longer while still enjoying many of its benefits. British people will still be able to travel, to live and to work in the EU. Student will be able to go study in other countries within the EU and investors will have access to foreign EU markets… The UK is part of Europe and will always be…
So let us look at the short and long-term implications and try to weigh the pros and cons of this controversial decision to leave the European Union.
Short-term pain for long-term gain…
Almost everybody agrees on one thing: there will be cost to leave the European Union. The real question is: is this upfront sacrifice worth the upcoming potential benefits?
It is clear that in the short run the economy is likely to suffer as savings rates will go up and less investments will be made by companies as a result of the confusion and uncertainty. So the real cost is caused by fear. Fear resulting from confusion and confusion resulting from ignorance…
People get scared, decrease their spending, cash in their stocks, and hide their money under their mattress. Companies delay investments, cut costs, and wait to see what happens next. These behaviors cause the markets to not effectively work and can lead to a recession. The reason why this does not scare me too much is that the problem is clearly more psychological than structural.
A psychological issue can be rectified faster and easier, especially when the source is a political confusion. Over the short run, psychology decides what happens in the market, and it is hard to anticipate when people will switch from fear back to greed… What is certain is that this change will happen as soon as the confusion is over and the markets get back on track.
It is interesting to note that the movements of the public financial markets do not correlate with the actions taken in the private markets. As an example, during the first and second day after the referendum, the UK REITs lost tremendous value due to very large selloffs. Investors panicked and sold everything as quickly as they could. On the other hand, did the REITs sell their real estate portfolios in the private market following the decision to leave the EU? No, they didn't. Private market actors took a step back and put a hold on their decisions to wait for the uncertainty to clear itself. The panic selling is happening in the public market which is overly short-term oriented - nothing else matters than next quarter! There is no panic selling in the private market, but a slowdown in market activity, as sellers and buyers prefer to wait for clarification. So there is a clear disconnect between private and public markets in the short run that could potentially create an opportunity for sophisticated investors to invest in certain UK securities.
The potential long-term benefits are forgotten…
First off, leaving the EU will result in immediate cost savings, as the UK will not have to pay any membership fee anymore. In 2015, the UK's net contribution was £8.5 billion, and this can now be allocated for other uses.
From a sovereignty standpoint, the UK will regain stronger control over its own policies and regulations. Few disagree that the EU membership creates restrictions that would not exist otherwise. The UK will now regain some of its power and be able to develop its own policies regarding taxation, immigration, corporations… independent from the EU.
Britain will now also be able to establish its own trade agreements. While this will take time, many very rich European countries, including Norway and Switzerland, already follow this approach. Norway has access to the single EU market without being bound by the EU regulations on many areas including agriculture and justice. Boris Johnson, the UK Secretary of State, remains confident that the UK will be able to strike a deal as the Canadians have done based on trade and getting rid of tariffs. It is not in the interest of anyone, including Germany to put tariffs on trades with the UK. Remember that the UK remains Germany's strongest trading partner within the EU with a trade surplus of over €50 billion. By making the life harder for the UK, they would hurt themselves in many aspects. They have to focus their attention on the interests of German citizens and German companies, and today the UK is a very important market for Germany, especially its exporters.
You get where I am going with this: I don't expect trade deals to change much at all. Many of the relationships that the UK has today will continue exactly as is today or just be reformulated. The long-term practical implications of Brexit are probably significantly less than what people are anticipating. Norway and Switzerland are doing just fine without being members. They are both some of the richest countries on earth, and in many aspects they are actually performing much better than the other EU countries.
There are real reasons why British people decided to leave the EU, and if the long-term implications were very negative, I highly doubt that they would have even had this referendum in the first place. Many economists argue that leaving the EU will be very beneficial for the UK in the long run as they will regain control over their economic policies, regulation and their taxation. The large British bank, Barclays (NYSE:BCS), anticipates that exiting the EU could even make the UK an even stronger "safe haven" for foreign investors that want to diversify their holding away from the EU. Let's remind ourselves that the situation within the EU is pretty scary as well, and negative interest rates are not attractive to anyone.
A Temporary Problem to the UK Economy
This confusion will not remain permanently, and measures have already been taken to reassure the markets. Boris Johnson, the Secretary of State of Foreign and Commonwealth Affairs, already stated that implications will be minor and that the fears are unreasonable.
EU citizens living in this country will have their rights fully protected, and the same goes for British citizens living in the EU. British people will still be able to go and work in the EU; to live; to travel; to study; to buy homes and to settle down. As the German equivalent of the CBI - the BDI - has very sensibly reminded us, there will continue to be free trade, and access to the single market. Boris Johnson.
Again, if this is true and free trade sustains between the UK and the EU, what big deal is it after all?
How does Buffett allocate his capital? Does he worry about the macro or political environment or the views of the people when allocating his capital? No, he doesn't. He seeks to determine how much an asset is likely to earn him over the 5 to 10 years or more. If he can determine a range of likely, he will buy it if he can get it at a reasonable price in relation to his analysis of the quality of the asset.
In the 54 years we have worked together, we have never forgone an attractive purchase because of the macro or political environment, or the views of other people. In fact, these subjects never come up when we make decisions. Warren Buffett
Buffett's recommendations have rarely disappointed and you have now an opportunity to take advantage of people's panic to buy strong businesses at cheap valuations in the UK.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.