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Brexit Fallout Could Last for Years

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No one knows yet which side will prevail in Thursday’s referendum on U.K. membership in the European Union, but if votes to “leave” top those to “remain,” financial markets are expected to tank.

“Markets haven’t priced in any of this,” says Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics, referring to a “leave” victory.

And the fallout could last for years, marking Brexit as the biggest shock to financial markets since the 2007-2008 financial crisis.

Polls from a day before the vote were too close to call – an online poll published Wednesday showed a “statistical dead heat,” with 45% in favor of leaving and 44% for remaining, but London’s famous bookmakers give favorable odds for the “remain” votes to win out.

Also favoring “remain” are the latest data from the U.K. Electoral Commission showing a record 46.5 million registered voters, suggesting a high 60% to 70% turnout that is expected to favor staying in the EU.

If “remain” wins, a mild relief rally is expected in global markets, then it’s pretty much back to life before Brexit, though some analysts say the precedent-setting vote could inspire other EU members to hold their own referendums.

If it loses and Brexit wins, turmoil is expected to follow, both financially and politically.

For starters, the British pound and FTSE 100 index, which tracks the top 100 stocks listed on the London Stock Exchange, could plummet 20%, according to analysts, and ultimately, says Kierkegaard, a massive restructuring of global asset allocations would follow.

He says financial services companies operating in London, including non-U.K.-based banks that use London as a gateway for their European business, would be especially vulnerable.

(Check out all of ThinkAdvisor’s news and analysis on Brexit.)

At the same time “safe-haven” assets like the U.S. dollar, gold and Treasuries could rally, as they did last week when sentiment was favoring a Brexit victory.

“The U.S. is still the safest place,” says Simon Calton, CEO of Rycal Investment Group, based in southwest England but with offices in the U.S. “Invest in U.S. dollars … diversify and look for a long-term strategy.”

Maxwell Gold, director of investment strategy at ETF Securities, says the biggest impact of a U.K. exit from the EU will be on currency markets which, in turn, is good for gold, but he doesn’t expect the yellow metal will trade outside its recent $1,200 to $1,300 per ounce range. He favors the SGOL fund, which invest in gold bars.

The impact of Brexit beyond certain markets is not so rosy. The U.K. is a major trading partner of the U.S., which last year exported over $55 billion worth of goods to the U.K. and invested more than ten times as much, while the U.K. has invested about $500 billion in the U.S. and employs more than 1 million employees here.

Peoria, Illinois-based Caterpillar (CAT) is just one example of that two-way street. The heavy machinery manufacturer employees 9,000 workers in six plants in the U.K., which it uses as a gateway for exports throughout Europe.

JP Morgan (JPM) is another. It uses the U.K. as an entry point into its business in other EU countries. Both companies plus eBay (EBAY) and BP (BP) are on Zacks Equity Research’s list of the  “4 Stocks That Could Plunge” if Brexit wins out.

Those are just some of the reasons financial advisors and investors need to pay attention to Thursday’s vote across the pond. The world is watching.

In the U.S., the heads of the Treasury, Commodity Futures Trading Commission and Securities and Exchange Commission discussed Brexit in their regularly scheduled closed-door meeting  of the Financial Stability Oversight Council on Tuesday.

On Capitol Hill, Fed chair and Council member Janet Yellen, who did not attend that meeting, told Congress on Tuesday that a vote in favor of Brexit would be “significant” for the U.K. and Europe and lead to economic “uncertainty and volatility that would negatively affect financial conditions” not only in the U.K. but the U.S. economic outlook as well.

“The dollar and other safe-haven currencies” would strengthen, and the Fed “will consider those impacts as we make future decisions on monetary policy,” said Yellen.

When asked if a Brexit victory could throw the U.S. economy into recession, Yellen said she didn’t think “that’s the most likely case, but we’ll have to watch it carefully.”

If there is a Brexit victory, advisors and investors should watch carefully the potential fallout, including:

— Whether other EU members seem interesting in following suit. “The big risk is that Brexit happens and others follow,” says Simon Calton, CEO of Rycal Investment Group, which is based in Southwest England. “All of this creates uncertainty for market and lack of confidence, when confidence is key to any marketplace doing well.”

Complicating the potential fallout is the structure of the EU itself: 28 member countries, only 19 of which use the euro. The U.K is not one of them but it has “kept balance” for those countries that don’t use the euro, says Sassan Ghahramani, CEO of SGH Macro Advisors, a macro-policy research firm serving hedge funds, money managers and financial policymakers.  

— How the EU responds to the U.K.’s exit and ultimately how the exit is structured. There is no blueprint for something that’s never happened before, and an exit is expected to take at least two years. Will the U.K. still have access to European markets, which account for more than 40% of its exports?  How will it negotiate new trade deals with countries inside and outside the EU? Will Scotland again hold a referendum to leave the U.K.? Will the U.K. fall into recession?

Although Brexit is a vote about an economic relationship — which can have a dramatic impact on economies and markets — it is at its heart a political move by a prime minister responding to divisions in his party. David Cameron orchestrated the referendum in response to growing sentiment in his Conservative Party wanting out of the EU in order to limit immigration and control domestic borders. But no matter the outcome, Cameron will be weakened and if Brexit wins “the economic costs for the U.K. will be very significant,” says Kierkegaard.

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(Check out all of ThinkAdvisor’s news and analysis on Brexit.)