For asset owners, the Brexit vote shows the hazards of market timing and failure to have a risk management program in place well before a crisis.
The anticipation of the referendum and its immediate outcome created immense anxiety about the markets. All the major equity markets declined in the immediate aftermath, as well as major currencies, although the yen strengthened against the dollar.
But stepping away a few days from the outcome of the U.K. vote to leave the European Union, some of the market declines have been reversed. As of the close July 6, the FTSE 100 index of U.K. stocks and Standard & Poor's 500 were up from the plunge the day after the vote, while the CAC 40 and DAX index of French and German stocks continued to fall and the FTSE 250 has rebounded from is post-Brexit low.
The U.K. rebound brings to mind the resolve of the British — keep calm and carry on — and is a reminder that markets tend to overreact.
For asset owners, the reversal shows the challenge of trying to time the market, as well the difficulty of putting into place a risk management plan in response to an immediate crisis. But those with risk management programs in place would not only be prepared for the downturn, but also to capitalize on opportunities from falling prices to bolster expected returns.
As James Paulsen, chief investment strategist at Wells Capital Management, Minneapolis, has said: “The financial market doesn't have to have a problem for there to be a problem.” Asset owners have to keep in mind the financial markets are not the same as the economy or political markets. Financial markets don't necessarily move in tandem. Financial markets, for example, can rise even in a down economy as they correct underpriced assets.
The U.K. was warned a vote to exit from the EU safe-haven would have dire financial and economic consequences. But the U.K. equity market has climbed, while the French and German markets have fallen. Have institutional investors priced all the implications of Brexit into the markets? In an efficient market based on what's known now, they have. Even so, as new developments on the Brexit consequences identify new ramifications, investors will have to keep in mind the relative impacts of the markets on their portfolios. Compared to the U.S. equity market capitalization of $23.3 trillion, the U.K. market represents $3 trillion; the French market, $1.7 trillion; and German market, $1.6 trillion In short, the three European countries represent a small part of the global stock market. So any downturn or recovery will have a more limited impact on globally balanced equity portfolios.
