By: Tom O’Connor, WorthPointe Financial Planner · Los Angeles, Orange County CA

IN THIS ARTICLE:

1) Britain has voted to leave the European Union. Could this be the start of a protectionist trend? What would this mean for investors? 

2) Hours after the vote, stocks were down slightly. Gold and long-term U.S. bonds were up slightly. Should we get in on this trade? Is this a sure bet, or are there opposing trends on the horizon? 

3) Does this change our core investing approach? What should we be talking about as a result of Brexit?_____________________

Last week, Britain voted to leave the European Union. Early anecdotal evidence attributes this to a protectionist, isolationist impulse. We see evidence of these impulses in the current U.S. presidential election campaigns, and in calls from other European countries to hold similar votes about the EU. You might wonder whether any changes in your portfolio should be made as a result. 

Taking the long view, the fundamental philosophy we follow should continue to work well. (In a nutshell, we use broadly diversified, low-cost mutual funds for global exposure to stocks, and we use relatively safe bond funds to seek income as well as the ability to buy more stocks, when stocks drop dramatically from time to time.) 

We remain confident that stock values will grow over the years as the global economy grows, so our core strategy will continue to work well. It does require that you remain invested through market cycles, and allow us to rebalance and buy even more stocks when they have fallen. This strategy is financially very rewarding, although it can be unsettling sometimes (e.g., watching us buy stocks when they “are falling”). 

We have enjoyed six years of generally increasing stock values from 2009 through 2014, followed by 18 months of more or less sideways markets (with U.S. stocks faring better than most foreign markets). We continue to rebalance your holdings to stay near your target allocation to stocks. It is inevitable that stocks may turn downward at some point.

If you feel any impulse to sell stocks when they decline, or will not let us rebalance to buy more stocks when they are down, we should definitely talk about whether to reduce your target allocation to stocks. On the other hand, if you can stick with the program to keep the investments working for you, the more you allocate to stocks, the more your portfolio should grow over longer periods. That’s where we want to be.

We have seen some clients succumb to fear and sell when asset values are down. A small number of clients we worked with in 2008 insisted that we sell all their stock holdings that year, saying “I can’t afford to lose any more money.” But that just locked in huge losses, which would have been entirely recovered within just another two years or so. Together, we must not make that mistake. Please let us know if you would like to discuss your allocation to stocks. 

It is tempting to make tactical trades based on what has just happened in the markets (assuming we can predict “what will happen” down the road). However, it is not possible to foretell future events with complete accuracy. Thus, we avoid making bets with your money, even when future events seem clear as daylight.  Events have a way of surprising people. Last week’s vote is a great example: markets were surprised that Brexit passed, and even if markets now form a consensus about future events, further surprises can occur. 

Nonetheless, we want to ensure that you are adequately protected against the worst investment outcomes. One very damaging scenario would be a return to 1920s-style economic protectionism. While modern treaties prohibit the sort of tariffs that caused issues then, countries can still restrict capital flows, restrict immigration (labor flows), delay imported goods at the borders and manipulate currencies lower (to discourage imports). If this contributes to a global economic slowdown, it is possible that stocks could decline, while long-term government bonds could increase in value. 

This is why Brexit has moved financial markets: protectionism harms economies and reduces stocks’ earnings power. 

During the days immediately after the vote, stocks moved down a few percentage points, while gold and U.S. Treasuries rose by a few percentage points. 

Should we buy gold and long Treasuries to get ahead of future protectionist moves? This would be betting on a global slowdown. 

As a counter-argument, a new president might stimulate the U.S. economy by taking on additional debt to finance domestic jobs rebuilding infrastructure (e.g., roads and bridges) in a sort of modern Work Projects Act. This would stimulate domestic spending, and could lift economic growth. To pay for this work, the government could shift from repurchasing huge volumes of bonds to issuing huge volumes of bonds. The surge in supply might mean higher rates — and therefore lower prices to long-term U.S. bonds. (Taking the very long view, the government could then repurchase old bonds in the open market, at less than face value, effectively allowing them to be “paid back at a discount” as Trump recently quipped.) 

In other words, we might be so focused on Brexit and protectionism that we buy long bonds today. But as the Fed’s efforts at stimulus are increasingly ineffective, if they issue bonds to pay for direct fiscal stimulus, we might regret having bought those long bonds. If both events occur, which motive force would prevail?

Similar opposing forces could develop in Japan, where “Abenomics” is not producing desired results, and in various European countries, where unemployment is creating fiscal stress and political instability. Who can say how this all works out?

Again, our inability to accurately predict what the future may bring is why we do not make tactical bets with your money. Many rigorous studies of active managers’ attempts to predict and profit from events shows that it is a loser’s game. We do know this: some guess right, some guess wrong and it’s expensive to pay active managers to make guesses. The world has a way of surprising all of us. 

We’ll stick with the program that has been shown to work best over time. We feel very strongly this is the best approach for all our clients.
We want to be sure we are targeting the right portion of stocks in your portfolio, so let’s talk if you have any concerns. We appreciate your business, and investing thoughtfully is a key component of doing all we can to ensure your financial success.