There’s been no shortage of commentary today on the impacts of the United Kingdom’s vote to leave the EU last night.  Global capital markets have witnessed a profound “attitude adjustment” as the run up to the vote was dominated by institutional investor confidence in the remain vote.  All kinds of volatility and price records have been set in the overnight and into this morning. From IOI’s standpoint, this represents a pretty material change in the world order and the global economy.

Privately, we did put in place a speculative short position based on the possibility of a LEAVE vote and you can read about how to structure such a “catastrophe hedge” here. We don’t typically talk about such speculation because it is outside the scope of the valuation-based process we teach at IOI, but these kind of tools can be useful to have in your tool box in times of perceived distress.

On Brexit, here are 5 things an IOI investor must consider in the face of this macro change / market risk increase.

  1. Stop, relax and think.  I give this very same counsel to my children when faced with a problem.  The media is paid to make the biggest deal possible out of any event it latches onto.  Best to take a walk, think hard about what’s happening for ourselves and then come back to our investments.
  2. Look at your portfolio and think about your investments’ direct exposure to an interruption in the relationship between Britain and Europe.  This is all about understanding revenue impacts for the businesses you own.  For example, British and European banks will likely be harmed, as well as industries associated with travel and expatriate services.  The going relationship of British based firms selling significantly into the EU and vice versa will change and this uncertainty should concern shareholders.  Bottom line, take a hard look at what you own.
  3. Consider the implications of increased cross border trade frictions globally, as well as a stronger US dollar on your portfolio.  The number and severity of populist, anti-free trade movements is growing in developed markets around the world.  Frustration with perceived ineffective political leadership is causing the populous to chuck long standing associated institutions in favor of an uncertain outcome.  In this case, it would appear the devil we don’t know is preferred to the devil we do.  Increased costs from reduced trade and dollar strength are likely outcomes to check your portfolios against.
  4. Global central bank / central planning policies are beginning to fail under the weight of “human” economics and this will add further uncertainty to capital markets.  Developed markets’ central banks have attempted, with some success, to step into a policy gap created by stalled political leadership.  Instead of acting to reform fiscal policies that create an environment for growth, growing sovereign debt positions have constrained politicians ability to act.  Low to negative interest rates here and abroad have not inspired economic recovery because our human minds are not behaving the way economic textbooks would have led policy makers to believe.  Indeed we are smart enough to see that the little growth we’ve seen has come from the smoke and mirrors of debt increases vs. durable growth led by investment.  Productivity growth has slowed and the businesses that drive our developed market economies are struggling to keep up margins. This weak period of expansion can best be described as “fake growth” driven by financial engineering.
  5. Understanding and applying disciplined valuation principles is more important than ever right now.  As we talked about in our AAPL Learning Call for members just last night (as the gravity of the Brexit decision was taking shape), understanding how a company makes money is our anchor for knowing what to do with individual investment positions and a total portfolio.  Brexit will impact some companies greatly and others very little or by indirect effects on consumption.  If we understand the make up of our investments’ revenue, we can immediately see which might be durably impaired and which, while the stock price falls, may have little to no durable effects.  Then we adjust our holdings and exposure accordingly. Most important, we stop running around asking, “do I sell everything?”.

So, Brexit has happened and the implications will likely be far reaching and unknowable, so as thoughtful investors, we must start by stopping, (turning off the babble box), relaxing (this can be done by working out what you think your worst case outcome is and getting comfy with that or not) and then thinking carefully about how to go forward.

Invest Intelligently…