Brexit: What Happens Now

I really didn't think UK voters would opt to leave the European Union. Not that I'm a big fan of the EU — it's a pretty flawed concept. But the trade agreements and shared currency for the geographic region is a good idea... at least in theory. The problem is obvious: how do you get the differing cultures to cooperate?

Thursday's UK vote offered up the simplest answer: you don't.

Now we'll see what the fallout is. UK Prime Minister David Cameron has resigned. The British pound is getting killed. European banks were crushed on Friday, down 15–25%. U.S. Treasury bond yields made their biggest one-day jump ever, and oil is getting creamed. The Dow closed down over 600 as I write.

It might be tempting to say this extreme sell-off is an overreaction. And I hope you are looking at the stock price declines as an opportunity. Because that's what it is: an opportunity. Anytime you see sharp declines, it's an opportunity to buy quality stocks on the cheap.

The question is, when? When do you step in and buy the freaking dip (BTFD)?

Well, I don't think it's quite time to buy just yet...

Now that the UK has voted to leave the EU, there's a lot of repositioning that has to happen. Currency trades involving the euro and pound need to be adjusted, for one. The British pound is getting killed. There is a high probability that the English enter recession in the near future.

But to me, the bigger risk for you (and me) has to do with the forced selling that can emerge at time like these...

When you get unexpected events that crush prices like this Brexit thing, sometimes big investors will get caught leaning the wrong way. Like, what if you bought the British pound, thinking, there's no way the Brits would vote to leave?

Yeah, so you know some hedge funds out there are getting punished. And that can get the ball rolling. Investors will start pulling their money out, then funds have to sell other assets to meet redemptions. Maybe they start getting margin calls and have to sell. That's the type of thing that happens when investors get surprised. And the fallout can send the markets falling much further than they otherwise might.

So I think the chances are pretty good that it's gonna get uglier out there before it's all said and done.

Globalization in Reverse

An analyst from Bank of America described the Brexit vote as globalization in reverse. It's worth pondering what this might actually mean.

For the last 30 years or so, free trade deals, the Internet, the breakup of the Soviet Union, and the emergence of China has created a truly global economy. Today, money moves pretty freely around the globe to find the best returns. Chinese can buy U.S. real estate, Apple can sell phones in Australia, BMW builds cars in South Carolina...

Unfortunately, when you say globalization, all some people see is jobs getting shipped overseas. That's a somewhat valid concern — a free global economy does mean manufacturers can seek out the lowest costs for their goods. That's why a pair of Levi's today costs the same as they did in 1978.

The alternative to free trade is protectionism. The government uses tariffs and trade restrictions to protect jobs against change. After all, if we don't allow cheap Chinese goods into the U.S., well, hey, we can pay more for stuff and support those U.S. manufacturing jobs...

Right now, exports from the U.S. are 13.5% of GDP, about $1.5 trillion. Throw in services, and it's $2.2 trillion. That's a lot to jeopardize by adopting protectionist policies.

Make no mistake: the Brexit vote is about protectionism. The UK doesn't want to bail out Greece and others. It doesn't want to take in refugees/immigrants from the Middle East. It's understandable that it wants to control its own destiny. But that's not necessarily the easiest road to take.

There were a bunch of articles about how UK voters that cast "leave" votes are regretting their choice as they see their currency and stock market plunge...

It's on the Table Here, Too

The same issues that were just voted on in the UK are at play here in the States. The notion of protectionism appeals to a lot of voters. And maybe it's the right thing to do over the long term. Maybe.

The U.S. does use protective tariffs to protect U.S. goods from unfair competition, usually from China. Just a couple weeks ago, we slapped some hefty tariffs on Chinese steel, because the Chinese government subsidizes its steel industry so the Chinese steel companies can sell their product much cheaper than U.S. producers.

This is called "dumping." And the U.S. reaction — slapping import tariffs on this steel — is absolutely the right thing to do against this type of unfair trade practice. It's not the same thing as protectionism.

A lot of Americans want the U.S. to become more protectionist. They want to curtail immigration, stop fighting wars in the Middle East, stop bailing out other countries, and so on.

These are reasonable things to want for our country. But they will come at a cost, if the people decide to move in a protectionist direction.

One more thing regarding the stock market: Keep an eye on oil. That is our canary in the coalmine. Stocks will not be able to rally if oil is down. When oil starts rallying, that will be my cue to buy stocks.

Until next time,

Briton Ryle

@BritonRyle on Twitter

An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.