Global stock markets are recovering somewhat after losing an estimated $3 trillion in the two trading days following the UK referendum vote to leave the European Union. Markets were not at all positioned for the results of the vote and reacted even more strongly than we had feared. The UK currency, the sterling, fell to a 30-year intraday low on Monday, June 27th; and despite the subsequent rally, still remains, as we write, 9% below the level of last Thursday, June 23rd. Standard & Poor’s cut Britain’s triple-A credit rating down two notches to AA. UK banks, which are likely to lose their ability to directly service EU clients and will also be hurt by likely cuts in interest rates, were hit heavily, with shares of Barclays (LON:BARC) falling some 17%.
The largest UK ETF, iShares MSCI United Kingdom (NYSE:EWU), tumbled 15.5% in the two trading days after the vote. Despite the market rebound , it is still down some 10% from last week’s level. We currently have no direct UK ETF positions in our International or Tactical Trend Portfolios and have not had for some time. We do get some small (less than 5%) exposure to the UK through broad-based multi-country ETFs. That compares with the UK’s 10.9% weight in the benchmark iShares MSCI ACWI ex US (NASDAQ:ACWX) Index. At a time when heavily oversold markets start to rally, attractive buying opportunities often arise. However, we are not inclined to commit capital to the UK market at this point. We need not repeat here the long list of medium- and longer-term financial and economic uncertainties facing the UK. We are particularly concerned about the political chaos in the country over the next several months.
Both of the major parties are seriously divided following the referendum vote. Prime Minister David Cameron announced he will resign following his unsuccessful campaign to keep the UK in the EU. His Conservative Party plans to complete its leadership contest in early September. The front runner appears to be the former mayor of London, Boris Johnson, who was a leader of the Leave faction of the party. Other contenders are Theresa May, the home secretary, and Jeremy Hunt. The process of choosing a leader is straightforward: the MPs select two names that are sent to the party, which chooses one.
The chaos is more evident on the Labor side, where there are a large number of conflicting factions. The current leader, Jeremy Corbyn, Tuesday lost a no-confidence vote in which 172 Labor members of Parliament voted against his leadership and only 40 MPs supported him. That followed more than forty resignations of MPs from his shadow administration andmore have followed. The revolt by the Labor MPs was mounted in reaction to Corbyn’s very weak performance in supporting the Remain campaign. As the no-confidence vote is only advisory, Corbyn insists he will not budge; but the revolt looks likely to trigger a leadership contest in which Corbyn would need the support of 50 MPs in order to stand, regardless of the popularity he may have among the party membership.
The Liberal Democrats, meanwhile, could profit from the splits in both leading parties and portray theirs as the only clearly pro-EU party. It is important to note that 48 percent of the electorate voted to stay in the EU. Should an early UK general election be held in the fall, which seems increasingly likely, the question of keeping the UK in the EU probably would be a central issue. A reversal of the Brexit referendum cannot be ruled out.
Adding to the political uncertainty is the likelihood that Scotland, where a strong majority voted to remain in the EU, will hold another referendum on whether to leave the United Kingdom. And Northern Ireland could well follow suit.
In view of all this current political uncertainty and the great financial and economic uncertainties over the medium and long run, we will continue to have no direct UK positions in our portfolios.