1. What is Brexit and how will it affect Britain’s economy?
Brexit was a referendum vote in the United Kingdom to determine if it will stay in the European Union or not.
In a surprise to the world, they voted to leave the European Union after more than 40 years of being a member.
Once the UK formally notifies the EU of their intent to leave, they have a two-year period to get it done.
The UK will need to renegotiate trade agreements with all of its trade partners that trade through the EU.
The uncertainty of what the new terms might be will likely depress investment spending and maybe more.
That uncertainty has caused the value of the pound to fall significantly.
2. What are the economic implications of Brexit?
Overall, we expect a somewhat slower rate of global growth and an environment of increased uncertainty.
Moreover, the implications of Brexit are broadly negative to varying degrees, though there may be some offsetting benefits for the global economy, including looser monetary conditions.
The adverse effects of Brexit will likely be most felt by the UK itself and other European economies. Political consequences could turn out to be far more significant with questions emerging surrounding the long-term viability of the EU.
For the rest of the world, the consequences appear much less significant, and we anticipate the overall reduction in growth to be relatively modest.
In the U.S., weakness is likely to be primarily imported through two channels: 1) a declining stock market, which could lower sentiment, and 2) a strengthening dollar, which will lower exports, decrease export-related employment, and create the potential for lower inflation.
3. How does Brexit affect your portfolio strategy?
Over a year ago, City National Rochdale reduced European equity exposure in client portfolios to just 5%, significantly less than the typical allocation of 10%-20% in a normal global asset allocation universe. This prescient investment decision means our clients have not been exposed to the same extent of volatility as investors who have a more normal allocation to European equities.
As of yet, we have not made any further significant changes to our portfolio positioning. However, we are carefully evaluating risks and the relative attractiveness of particular asset classes in light of recent developments.
For U.S. equities, we are considering whether the volatile and uncertain times ahead warrant a reduction in our modest overweight to growth stocks. Our current position in U.S. high dividend stocks is likely to be maintained.
With our exposure in EM Asia focused on domestic consumption and new-economy businesses, we do not see any material impact on our portfolio EPS at this point.
In fixed income, we will maintain our current positioning across government, investment grade, and high yield bonds. Weaker macroeconomic fundamentals, relative to equities, is better for fixed income assets, but requires careful monitoring of credit quality.
4. Did the Brexit vote alter your outlook for a Fed tightening this summer?
Yes. There was a small chance that the Fed would tighten at one of their summer meetings; now we believe that chance is gone.
The Brexit vote has created the potential for slowing economic growth in many countries, a secondary concern for the Fed.
The strengthening dollar, as a result of the flight to quality away from the UK, should hold inflation down.
5. Will U.S. economic growth rebound in the second quarter?
Although the disappointing start to the year added to the sense of unease over the strength of the current expansion, early indications are that growth is rebounding at a solid rate in the second quarter and we continue to believe the risk of recession remains low.
Better retail sales, home building, and industrial production data, along with a turnaround in forward-looking business activity indices, all suggest domestic demand is again gaining traction.
Most encouraging is what appears to be a pickup in real consumer spending, which is on track to increase at a 3% annual rate in the second quarter, versus about 2% in the first quarter.
Looking ahead, we expect the drag from energy investment and the stronger dollar to continue to weigh on the economy.
However, low gas prices, solid job growth, and improving income gains should help the consumer continue to carry the economy forward.
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