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Post-Brexit: European Markets Have Rebounded, but for How Long?

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The immediate aftermath of Britain’s exit from the European Union (EU) – known as “Brexit” – had all the hallmarks of a major financial crisis. And the narrow victory of British citizens that wanted to leave (51.89%) versus those who wanted to stay (48.1%) only added to the suspense.  

Once the referendum results became official, global financial markets, led by a collapse in Eurozone assets, went into a  tailspin.

ETFs tied to British stocks like the iShares MSCI United Kingdom ETF (EWU) fell 13.16% from June 23 to 27, while the CurrencyShares British Pound (FXB) dropped 10.03%. The rest of Europe’s stock market, as tracked by the Vanguard European ETF (VGK) followed suit by crashing 10.90% in just a matter of days.

The CurrencyShares Euro ETF (FXE), which is linked to the euro’s performance, held up much better but still managed losses of 2.56%.

All the steep losses suffered as a result of Brexit have since subsided but prices have not rebounded to levels that existed before the vote.

British and European equities were down only 4% and 4.6% as of the close Thursday, June 30 compared to double-digit losses just a few days before. Although the British pound is still down around 9% since the referendum’s results, some see a major buying opportunity.

“If you believe, as I do, that the pound will not be allowed to sink too far, it makes sense to go long the pound,” said Charles Sizemore at Sizemore Capital. “While there is a lot of bad blood between the UK and the rest of Europe right now, no one wants to see the UK fall into a genuine debt or currency crisis.”

Back in September 1992, when George Soros “broke” the Bank of England, the pound fell around 4% or about one-third less than it did the night of the Brexit referendum announcement.  This time around, Soros was long, not short the British pound, but reportedly made money in other markets because of his bearish global outlook, according to Bloomberg.

In a speech to the European Parliament on Thursday Soros said the Brexit vote has “unleashed” a crisis in financial markets reminiscent of the 2007-2008 global financial crisis of 2007 and will “reinforce deflationary trends.”

Time will tell if Soros is right but well before Brexit, the overall trend in European stocks and currencies had been down.

Over the past two years, the euro has declined 19.5% while the British pound has slid 22.3%. Over the same period, British stocks have fallen 19.7% and the rest of European equities are down almost 17%. By the bear market standard of a 20% decline from peak to trough, most of these markets are in a verified bear market.

For good reason, some advisors are maintaining a defensive posture by increasing cash exposure inside client portfolios. 

“At current yields I hate cash; but when it is generating strong relative strength scores, we must respect it,” said Matt McAleer, Managing Director at Cumberland Advisors.

Because Britain’s exit from the EU won’t happen overnight, the full economic impact of withdrawal from the EU probably won’t be felt for a number of years.

Once Britain invokes article 50 withdrawal from the EU, a negotiation period counted from the invoking date, not the referendum date, begins and, according to the rules, those negotiations can last up to a maximum of two years and be stretched further if both parties agree. Ultimately, it’s U.K.’s Prime Minister who decides on the timing of when to implement article 50 but even that is problematic now. The current PM, David Cameron, has resigned effective late September or early October, and has said the U.K.-EU negotiations should wait until his successor is in office, and, who that will be is unknown at this point.

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