On Friday, 24th June, we woke up to news that Britain had voted to leave the European Union (EU). This was an entirely unanticipated outcome and the reason I say this is because the financial markets were priced for Britain to remain in the EU and that conviction has been growing over the last couple of weeks. So the decision to exit the EU has caught the market off-guard and as a result the financial markets have suffered a significant decline.
What is Brexit?
Brexit is an acronym for “British Exit”. In the past, Western Europe consisted of several countries, each with its own trade, immigration, and economic policies. Trying to navigate these rules was inefficient and so in 1993, the EU was formed in order to mitigate these inefficiencies. Since then, the EU has helped foster long periods of economic prosperity for Western Europe.
In recent times however, due to economic recessions, there has been increased worry by the wealthier EU countries, such as Britain, that they may have to help bail out less wealthy EU countries in the near future. In addition, there were several other issues which impacted Britain negatively and as a result it seemed for Britain that being a member of the EU was more detrimental to its economy. Hence the Brexit process began a year ago and now… Happy Independence Day, Britain, I guess?
Let’s get to the crux of the matter – how does Brexit affect South Africa?
South Africa has strong trade links and investment links with the EU countries. Given that Britain has now exited, South Africa will have to renegotiate a trade deal directly with Britain and that deal may not be as preferential as what we have got now. 25% of our exports are to Europe and Britain is the largest trading partner within Europe. So there are significant ramifications for South Africa’s exports and we can’t really afford to see our exports come under more pressure. Why? With South Africa already struggling to grow its economy, with the current Rand volatility and the fact that South Africa is one level above ‘junk status’, Brexit only worsens the situation.
At the beginning of the year, I wrote an article where I mentioned that interest rates will be increasing this year. We have had one increase thus far. There was a good chance we were going to have another increase later this year. However, Brexit will result in significant negative implications for world growth and the FED (USA Reserve Bank) has indicated that it will most probably not be increasing interest rates for the remainder of the year (as lower interest rates help stimulate economic growth). The good news is that I personally do not think interest rates in South Africa will be increasing either for the remainder of the year.
Over a period of two years, Britain will systematically exit the EU arrangement. There isn’t a precedent for this which means many of the implications are unknown. The financial markets have taken a knock. Investments all over the world have declined and markets will continue volatile behaviour while it adjusts to the new reality.
Now would NOT be a good time to withdraw your investments because it is common for the market to over-react in circumstances where there are so many unknown variables and hence markets tend to decline more than necessary. I will be investing my money into the markets over the next few weeks. As the great Warren Buffett says, “Be fearful when others are greedy and be greedy when others are fearful.” At present, the market is fearful. Now is a good time to become greedy.