Wait, was there a Brexit? Second quarter market activity was fairly staid until June 24, when the world received the results of the referendum in the United Kingdom on whether it should remain or leave the European Union (EU). The “Leave” campaign won unexpectedly by a narrow margin. In reaction, stock markets around the world dropped, high-grade bond yields fell, the British pound fell, and the price of oil declined. European stock market were down 9% on average, with the Spanish and Italian markets each down 12%. Japan’s major stock index also dropped 8% on June 24. After a second down day on Monday June 27, the US markets rallied over the following three days to finish the quarter up about 2%, and bonds were up. In spite of the stock markets’ immediate rally back, the Brexit is a momentous event, as shown by the behavior of the British pound versus the US dollar.

Bonds traded in a narrow band during the quarter before rising sharply on June 24. The yield on the 10-year US Treasury declined from 2.3% on January 1 to 1.47% at quarter’s end. Real bond yields are turning negative again. The Federal Reserve will likely take no action between now and our fall presidential election. Depending on how the world stock markets stabilize over this period, the odds are high that the Fed will resume increasing rates after the election. Unemployment is now down to 4.7%. The Consumer Price Index (CPI) indicates that price inflation is running at 1.0%, but the Personal Consumption Expenditure index (PCE), which figures more strongly into the Fed’s decision making, was up 1.6% as of the last reading.

The Brexit vote was clearly a repudiation of the status quo. Many powerful figures including the leaders of the top five British political parties, over 1,200 corporate CEOs including JPMorgan CEO Jamie Dimon, half of the leaders of the FTSE 100 (the biggest companies in the UK), UK Prime Minister David Cameron, and President Obama, all strenuously argued for “Remain,” to no avail. In the near term, we believe stock market volatility will continue as the implications of the Brexit emerge. Market observers are already commenting that the US markets will be viewed as the only safe haven, providing buying support to our markets.

Speculation has begun over who might be the next country to leave the EU. This likely will precipitate questions regarding the long-term viability of the euro as a currency.

We have long rejected the conventional thinking that 30% of one’s equity portfolio should be invested in non-US securities. The Morgan Stanley All-World index, a popular benchmark index for advisors like Nelson Roberts, has non-U.S. exposure of 46.5%. Today, we have an extremely small position of 2% for the foreign developed market ETF and 3% for emerging markets. The impact on our portfolios from the reaction to the Brexit will be significantly muted by this relatively low exposure.

How will all of this play out? The day after the Brexit vote, UK Prime Minister David Cameron went to Buckingham Palace to tender his resignation to the Queen. However, we do not believe anything substantive will happen until his replacement takes office in October. The UK’s relationship with the US will remain unchanged. It will probably take years for the UK to negotiate new trade agreements with all of the remaining EU members. In the meantime, it will probably be trading as usual. Longer term, further disassociation amongst members will raise barriers to EU member growth in aggregate. This vote can be seen as a majority statement by UK voters that “whatever was working was not working for me, so I want something else.” This sentiment is prevalent here in the US on both sides of the aisle, evidenced by the support that both Donald Trump and Bernie Sanders garnered throughout the election primaries. Pre-vote polling in the UK did not detect this sentiment very well, which leads us to ask, “Could something like that happen here in the US?” For 35 years, the wealth and income gaps have grown steadily wider to levels today that compare to the late 19th century. This trend is ripe for a change. Unless Hillary Clinton can alter voters’ perception that she is the status quo candidate, it may work to her disadvantage.

Stepping back further, we see this sentiment as a global phenomenon which, at its core, represents the pendulum swinging between globalization and nationalization. The apogee of nationalization precipitated the last world war. Since then, trade barriers have been steadily reduced. We believe the Brexit marks a turning point, and that future developments will further raise economic barriers between countries. While the U.S. is not devoid of challenges, on a relative scale, we are perceived as a safe haven for global investment. Our view continues to be that the US will be the best place to invest for the foreseeable future.

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.