We have spent some time thoroughly discussing our reaction to the UKs decision to leave the EU. As you probably know we do not make asset class changes to client portfolios for short term reasons. Historically doing so is not prudent and rarely results in gains worth noting. In fact the opposite is usually true. The short term decline in the market has been severe and swift. It is, however, important to remember that fundamentally nothing will change for two years as the EU and Britain decide how to handle the exit.
Our challenge now is to look out further. What does this mean 3-5 years out?
Risk is one of the main things we manage for clients. This encompasses all types of risk; Economic risk, market risk, interest rate risk, to name a few. The Brexit vote however pushes Europe toward a risk that we usually mostly avoid. Political risk. Investing in mostly developed markets helps to minimize political risk to a certain extent. This is a risk often seen in emerging markets and under developed countries. We believe political instability is usually best managed by avoidance or a smaller percent of holdings. We believe the Brexit vote marks a time of potential political instability not seen in Europe in decades.
Most modern investment theory and "prudent" portfolios call for investment in international equities. For the most part we have agreed with these models but as we move to a more global economy and freer trade the term "international" has taken on a different meaning. For example, many US companies have a large presence globally and sell their goods in many countries across the world. This makes them "international" yet when modeling portfolios they are classified as US Equities. The same goes for many international companies as well.
As we look at the future of Europe, we are concerned about their economic growth for sure but we also know that oftentimes economies and market prices do not work in the same direction. The question we have to ask ourselves is whether we think stalled economic growth is a longer term concern for the European equity markers. Short term risks remain something we do not speculate on but we do make allocation changes based on longer term risks as we perceive them. This can be seen in our very low percentage holdings in emerging markets over the past several years.
During times like these I like to look back at some of the more influential books when it comes to investing. A quote for Professor Jeremy Siegel in his bookStocks for the Long Run…
"Fear has a greater grasp on human action than does the impressive weight of historical evidence"
Now go look at this chart shared by industry colleague Michael Batnick. Take note of how a balanced portfolio responds to “crisises”. If this indeed turns into a crisis then you can take solace in the market reaction to other major events.
We will be seeing many of you in the coming months to discuss changes. If, however, you want to talk now don’t hesitate to reply to this email and we can schedule a phone call. If we decide a change is prudent sooner than your meeting then we will reach out. We want to talk to anyone who is worried, concerned or just wants to talk things through. With that said, enjoy your Summer, vacations and family. Try to let us do the worrying for you.