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Britain Votes To Leave The European Union, Surprising The World

Stocks dropped 3.6% on Friday, the biggest drop since August 2015, after Great Britain's voters narrowly decided to leave the European Union.

Just days ago, Britain's exit from the EU had been regarded as highly unlikely.  The world was stunned by the vote, which was widely reported to have turned out more than 70% of eligible voters, and resulted in 52% favoring exiting the EU, and 48% who wanted to stay.

To be clear, Brexit is a political event but not necessarily a particularly significant economic event.  It certainly is not a systemic risk, like the collapse of Lehman in September 2008. 

The United Kingdom's vote to exit the European Union was triggered by a popular revolt against immigration policies being imposed by Brussels.  It was not a popular revolt against trade agreements or an economic fight.

Despite the U.K.'s leaving the EU, trade between the U.K. and Europe is likely to continue much the same as before the Brexit.  The Eurozone's economic outlook as a result of Brexit seems unlikely to change. That's the key:  Britain's economy as a result of Brexit is of much less importance to the global economy.

Pro-Brexit economists and financial leaders have indeed made some very persuasive fundamental economic arguments, and those arguments could help unleash economic growth in the U.K., now that Britain will be unfettered by the EU.

U.S. stocks are driven by the U.S. economic outlook and U.S. corporate earnings.  While "globalization" has become a household word, in reality, the U.S. economy is still relatively insular.

Consumer spending, a function of domestic income and demand, mostly drives about 80% of the U.S. economy, along with government spending and private investment.  Net exports account for only a small share of U.S. gross domestic product.  This is a very domestic mix compared to other world economies. 

Today, U.S. economic momentum is strong with full employment and rising incomes, and this is likely to remain the case until the Federal Reserve Board decides to slow down on economic growth, but that may be years off.  In fact, because of Brexit, the Fed's accommodating approach to liquefy the economy and foster growth is likely to remain intact.

While the Fed had talked in March of a possible interest rate hike, Brexit is likely to have made the Fed more "dovish" on rates and it may push off a rate hike for the rest of 2016.

Markets abhor uncertainty, however, even if the probability of a negative fundamental fallout seems to be quite low. The myriad ancillary effects of Brexit are apt to persist for a while and create some uncertainty. 

The U.K. will need to renegotiate its treaties with the Eurozone.  In addition, growing anti-EU sentiment on the continent could result in more political upheaval there.  Brexit will be a protracted process but a political process, and investors may adjust to the new reality in fits and starts, and further volatility should be expected.

While past performance is never a guarantee of your future results, broadly diversified portfolios are built to withstand economic shocks over a long period but are subject to emotional swings and volatility.  The S&P 500 remains a few percentage points below its all-time high and the U.S. economic outlook for the rest of 2016 is remains bright, despite the Brexit surprise.

We are here to answer any of your questions and will be keeping you posted within the days immediately ahead.

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