It’s official. Britain has voted in favor of ending its 43-year membership with the European Union (EU), and it seems to have taken just about everybody by surprise. However, the aftermath reaction to how Europe and Britain will manage a complex divorce over the coming decade sent global markets reeling.
London’s blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day, while Germany’s DAX market lost more than 7%. The British pound sterling is getting crushed (down 14% against the yen, 10% against the dollar). Compared to the global markets, the reaction among traders on U.S. exchanges seems muted.
It is important to understand that the current market disruptions represent are emotionally driven, an immediate panic reaction to what will likely be a long-term, ultimately graceful accommodation between the UK and Europe. When the dust settles, people will realize the panicked reaction to Brexit was a buying opportunity, rather than a time to sell. People who sell will realize they were misled by panic masquerading as an assessment of real damage to the companies in which they’ve invested.
What happens next for Britain and its former partners on the continent? Unlike other EU nations, Britain will not have to print a new currency, and British stores and businesses will continue accepting euros. On the trade and regulatory side, the actual split is years away. The British electorate’s vote is not legally binding (a fact many news outlets fail to report). It will not be until and unless the British government formally notifies the EU of its intention to leave under Article 50 of the Treaty of Lisbon.
If that happens, Article 50 sets forth a two-year period of negotiations between the exiting country and the EU. Since British Prime Minister David Cameron has officially resigned his post and called for a new election, the exit process probably won’t begin until a new Prime Minister is elected. Therefore, the UK is still part of the Eurozone for the foreseeable future.
After notification, attorneys in Whitehall and Brussels begin negotiating, piece by piece, a new trade relationship, including tariffs, how open the UK borders will be for travel, and a variety of immigration issues. Estimates vary, but nobody seems to think the process will take less than five years to complete, and current arrangements will remain until new ones are agreed upon.
An alternative being discussed is a temporary acceptance of an established model—similar to Norway’s. Norway is not an EU member, but it pays EU dues and has full access to the single market as if it was a member. However, that would require the British to continue paying EU budget dues and accept free movement of workers, which were exactly the provisions that voters rejected in the referendum.
Meanwhile, since the Brexit vote is not legally binding, it’s possible that the new government might decide to delay invoking Article 50. Parliament could also instruct the prime minister not to invoke Article 50 until the government has had a chance to further study the implications. A second referendum to undo the first is also a possibility.
The important thing to remember is that Wall Street is chasing sentiment, not underlying value, and the markets are currently being emotionally driven by what is perceived as an event but is really a long process that will be managed by people who aren’t interested in damaging their nation’s economic fortunes. Nobody knows exactly how the long-term prospects of Britain, the EU or American companies doing business across the Atlantic will be impacted by Brexit, but it would be unwise to assume the worst so quickly after the vote.
But you can bet that, long-term, everybody will find a way to move past this unexpected event without suffering too much damage. In fact, the current situation makes it a perfect time for European travel. You may not be able to travel to Europe in such a cost effective environment again. In the meantime, hang on, because the market roller coaster seems to have entered one of those wild rides that we experience periodically.