'Micro-economics is what we do, macro-economics is what we put up with.' - Charlie Munger
Markets were surprised by the decision of Britons to leave the European Union on Thursday. The British pound suffered its biggest drop in decades, the FTSE100 dropped over 9% before stabilising at 3.15%. European and other international indicies, including the US S&P500 (NYSEARCA:SPY), suffered similar damage. The surprise was all the more severe given that in the last few days markets were reflecting an increasing belief that the 'Remain' campaign would be successful. The sell-off reflects the economic consensus that leaving the European Union will lead to a worse economic outcome for the United Kingdom.
The vote was close: 52 to 48%; however, some parts of the UK, including Scotland and Northern Ireland, voted overwhelmingly to 'Remain' (62% of Scots voted in favour of remaining). Adding to the confusion, the British Prime Minister, David Cameron, has indicated he will resign and the Scottish First Minister, Nicola Sturgeon, has indicated Scotland will probably seek to hold another independence referendum (so that it can remain in the EU to reflect its citizens' wishes).
So what does the outcome of the vote really mean?
Political and economic effects
First, it is not binding. Referendums in the UK reflect the will of the people, but they have no legal effect. It will now be up to the UK Parliament to implement the will of the people - at a time, and in a way, of its choosing. Top 'Leave' campaigners, including Boris Johnson, indicated on Friday that the pace of change would be slow and deliberate; they have even indicated that Art. 50 of the Lisbon Treaty (which allows for negotiations to take place if a EU Member State wishes to leave) would not be immediately invoked, and have suggested that 'Leave' might not be fully implemented until as late as 2020. David Cameron also indicated that his resignation would not take effect for a few months.
There is a possibility that the 'shock' of the vote will provoke a short term economic recession in the UK - but even this won't be known until much later in the year.
In the short-term then, there will be very little political (and therefore economic) change.
The fact that nothing will change in the short-term will not, of course, prevent market volatility. If there is one thing markets hate, it is uncertainty. The 'Leave' campaign's success involves a decision by Britons to choose a future which has no clear defining features. What will Brexit actually look like? Will the EU punish the UK and give it an unattractive deal to discourage other would-be leavers? Will the UK be invited to join the European Free Trade Association (whose members are members of the European Economic Area, but not members of the EU)? Will Brexit even happen? (One possibility is that the European Union will negotiate (or offer) a more attractive package to entice the UK to remain; if that occurs, a further referendum might be required, or the UK Parliament might even make a decision to stay on its own).
Uncertainty will occur not only because the future of the UK's relationship with the EU is unknown, but because the outcome of the vote will embolden nationalists in other European countries who want to secede. Is this the beginning of the end of the European project of closer integration?
Effects on the businesses of US-listed companies
The impact of the vote on the underlying values of US-listed companies is easier to predict: probably very little, if any. It is difficult to see how Brexit could have any material long-term effect on the economic prospects of companies doing most of their business in the United States, even if many of them have significant international operations. Companies like MasterCard (NYSE:MA), Allergan (NYSE:AGN), IBM (NYSE:IBM) and Starz (NASDAQ:STRZA) are unlikely to suffer any long term economic effect. Is MasterCard really worth 4.43% less (Friday's decline) because the UK has made a non-binding election to leave the EU, which may or may not be implemented and in a way which is yet to be determined? It seems unlikely: whatever happens with the UK's relationship with Europe, life will go on: people will still make purchases on their cards, they will require medical treatment, their companies will require enterprise computing and consultancy services and they will keep watching TV (whether in the UK or elsewhere).
Of course, markets tend to react strongly to short-term events, whether that reaction is fully justified or not (it usually isn't). We expect that markets will (in the short-term) continue to be adversely impacted by the outcome of the vote. It is of course impossible to say exactly how much, and for how long, they will be affected. However, the reality is that the vote is unlikely to affect the underlying economic values of most US-based companies (and possibly those based in Europe or even the UK itself). That is what we as investors should be interested in.
Warren Buffett is often quoted as saying that the way to be successful in investing is to 'be fearful when others are greedy, and greedy when others are fearful'. Others are fearful now. It is time to take advantage of the present situation as a buying opportunity.
Disclosure: I am/we are long MA, IBM, STRZA, AGN.