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Bracing for Brexit

By Linda McDonough on June 21, 2016

Brexit has been tossing the stock market around like a rag doll in the last week.  The June 23 vote decides whether Britain will remain part of the EU, and up until recently the stock market had smugly assumed the status quo.

On June 10 a poll by British newspaper The Independent showed a 10 percentage point lead in supporters of Britain exiting the EU. The S&P 500 fell 2% from that date until June 20, when a new poll reversed that opinion, and the S&P bounced back.

While an exit from the E.U. is all but certain to create short term chaos in the markets, the practical significance of a possible break should be muted for companies with less international exposure. For this reason lately I have specifically sought out stocks with more domestic focus when finding buys for my Profit Catalyst Alert and Growth Stock Strategist portfolios.

Dysfunctional Family

I like to think of the E.U. as a dysfunctional family. Marrying 28 countries was a plan rife with potential conflict. Despite adopting the same currency (though Britain never did), and agreeing to unified trade agreements, each country is still bound by its own unique politics and economies.

Most of mainland Europe has united to survive the near collapse of its fiscally imprudent members. Greece, Italy and Spain, which have behaved like reckless teenagers, continue to be reprimanded and lassoed in by more mature siblings Germany and France.

The U.K., the reserved and steadfast elder of the Euro family, has produced the strongest economic growth of the group. While France, Germany and the rest of the Eurozone struggle to produce real GDP close to 1.5%, the U.K. is logging in growth above 2%.

As you can imagine, once the U.K. chaperone leaves the room, a raucous party may break out. And the most frightening consequence of a Brexit is the blow to the confidence and cohesiveness that the Eurozone has so aggressively sought to create.

Stay Home

On implication of a U.K. exit is a requirement of renewed trading term negotiations. Any U.S. company that imports or exports a large amount of product to the U.K. will need to rework quotas, tariffs and fees. Uncertainty over these terms and the possibility of higher fees would hurt those exposed to Brexit risk.

The departure of the U.K. would also likely drag down growth in the rest of the Eurozone. The transition itself may cripple expansion as companies wait to see the fallout from the decision. A company whose growth plans involve increased demand from Europe will hit speed bumps.

Of course the world’s economies are so tightly woven it is impossible to avoid some of the messy trading that will ensue if Britain departs. There is a trickledown effect from a foreign slowdown. The curtailment of growth hurts global companies whose customers and employees then reduce their own consumption of domestic goods. Yet the effect will be small for U.S. domestic-only companies.

 


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