Fears, Facts, and Brexit

The politics of the European Union have dominated conversations about investing in European equities over the past decade. Who will stay? Who will leave? How will markets react? 

Britain’s vote to leave the European Union provides an excellent case study to evaluate the impact of EU politics on equity markets. In the months leading up to the Brexit vote, economists, bankers, and investors predicted that a vote to leave the EU would be a major destabilizing event, with devastating consequences for Britain and British equities. But have these fears been justified? And since the UK’s referendum to leave the EU in June 2016, what can we learn from British equity markets over the past two years?

In this week’s note, we contrast the fears and the facts.

Fear: Voting to leave the EU would create uncertainty and wreak havoc on UK financial markets.

Fact: The UK equity market has compounded at a 10% annualized rate in the two years since the Brexit vote. This return is similar to the UK equity market’s long-term average return of 11% since 1975. Notably, the UK equity market has been relatively calm in the two years since the Brexit vote (11% volatility) versus an average volatility of 19% over the 41 years prior to the Brexit vote.

Figure 1: UK Equity Market Return before and after Brexit Vote (1975—2018)

Sources: Ken French Data Library and MSCI

Fear: Leaving the EU would create job losses in the UK as companies relocate to mainland Europe.

Fact: The UK unemployment rate was 5% at the time of the Brexit vote in June 2016. Since then, it has declined to 4% as of May 2018.

Figure 2: UK Unemployment Rate before and after Brexit Vote (1971—2018)

Source: Office for National Statistics

Fear: Leaving the EU would make the UK economy less competitive due to a loss of trade agreements.

Fact: Since the Brexit vote, the UK’s GDP growth has averaged 1.6% per year. While this is slightly lower than the historical average growth rate of 2.3% since 1955, there is nothing unusual about a 1.6% GDP growth rate in the UK. Over the past 63 years, GDP growth in the UK has usually been somewhere between -1.7% and 6.3% (i.e., one standard deviation from the historical average). The 1.6% GDP growth rate over the past two years falls squarely within that range.

Figure 3: UK GDP Growth before and after Brexit Vote (1955—2018)

Source: Office for National Statistics

Fear: Brexit would create massive uncertainty in markets, making it extremely difficult to make good investment judgments.

Fact: Value investors who stayed the course in UK markets since the Brexit vote have been handsomely rewarded for their discipline. The uncertainty created by Brexit has indeed had a negative impact on growth stocks, but value stocks have thrived in this environment.

Figure 4: UK Value Premium before and after Brexit Vote (1975—2018)

Sources: Ken French Data Library and MSCI

The fears about Brexit were overstated. Too many investors let political commentary influence their investment decisions, but the facts suggest that tuning out this type of noise in favor of judgments based on long-term historical base rates might be the better course of action.