What Brexit Means for U.S. Investors

UKThe United Kingdom’s break from the European Union will usher in a period of uncertainty and volatility for U.S. investors as the ripple effects of “Brexit” make their way across the pond. News of the break–all the more jarring because global markets rallied sharply on the day of the vote on the assumption that the U.K. would stay–sent markets reeling once the outcome became clear. The Dow Jones industrial average plunged 610 points, or 3.4% on June 24, to close at 17,401. Standard & Poor’s 500-stock index sank 3.6%, and the Nasdaq Composite index tumbled 4.1%.

No one can say for sure how events will unfold–politically, economically or financially–since exit from the union has no historical precedent. But prudent investors who refrain from overreacting and who keep a sharp lookout for bargains will survive Brexit unscathed, and maybe even come out ahead of the game.

The first challenge is not to make any snap decisions about your portfolio. “Selling what you wish you had sold yesterday is rarely the right reaction,” says Andrew Bell, chief executive of Witan Investment Trust, in London. “Better to wait for opportunities to be revealed by volatility than to be a part of it.”

In fact, markets tend to overshoot when facing geopolitical shocks of this nature, so things could get worse before they get better, says Jeff Kleintop, chief global investment strategist at Charles Schwab. He points to three recent events that may provide a blueprint: The Japan earthquake and related nuclear accident in 2011, the U.S. debt-ceiling standoff later that year and the European debt crisis of 2012. In all three instances, single-digit-percentage declines on the first day turned into double-digit losses over time, with the S&P 500 losing 16%, 14% and 11%, respectively. But stock prices recovered in relatively short order. “It’s important for long-term investors to note that in each of these instances stocks rebounded to their pre-shock level in three or four months,” says Kleintop.

That doesn’t mean there aren’t gut-wrenching days ahead. Strategists at Bank of America Merrill Lynch see a recession looming in the United Kingdom and a double-digit-percentage selloff in European stocks as countries reconfigure their trade and economic relationships. Kiplinger’s believes that Europe will escape recession this year, but the odds are 50-50 for 2017.

The good news for U.S. stocks is that S&P 500 companies derive less than 3% of revenues from the U.K. Even so, a stronger dollar–the British pound plunged against the buck, to a level it hadn’t seen in more than 30 years following the vote–and renewed worries about the global economy will put a damper on growth here. Kiplinger’s sees U.S. economic growth of 1.8% this year, down from an earlier forecast of 2%. “The keys to whether the U.S. economy is affected significantly will be whether stocks tumble enough to have a major impact on business and consumer confidence and whether banks are affected such that they pull back on lending,” says Jim O’Sullivan, chief U.S. economist for High Frequency Economics.

In the end, Brexit could shave two to three percentage points from already anemic corporate earnings growth in the U.S., say BofA Merrill strategists. Stocks likely to suffer the most include multinational companies that do best when the economy is buoyant, including energy, materials, industrials, financials and technology companies. Defensive, U.S.-focused companies, including utilities, providers of telecommunications services and companies that make consumer necessities will be the least-scathed.

But others see Brexit as a speed bump, not a brick wall, for a bull market that refuses to die. “This will ultimately be looked back on as a buying opportunity,” says senior strategist Scott Wren at Wells Fargo Investment Institute. “Now is when you really need a steady hand.” Start by exploiting market volatility to rebalance your portfolio, taking recent heady profits in bonds and moving cash into shares of large U.S. companies. Although bargains in emerging markets and beaten-down Europe may beckon, “this is not the time to speculate,” says Hank Smith, chief investment officer of Haverford Trust.

With 20-year Treasury bonds yielding a scant 1.5%, and the Federal Reserve now even more likely to keep short-term interest rates low, now is the time to buy high-quality dividend stocks. “You can create a diversified portfolio of high-quality companies in every single sector with yields that are better than bond yields,” says Smith. Stocks he likes include Johnson and Johnson (symbol JNJ, $115.63), Altria (MO, $67.02), United Parcel Service (UPS, $104.41) and United Technologies (UTX, $98.89). Banks, which had been rallying on expectations of Fed rate hikes, suffered some of the largest Brexit losses, making some of them good buys now, says Smith. He recommends Wells Fargo (WFC, $45.71) which does almost all of its business in the U.S., and JPMorgan Chase, (JPM, $59.60), which, he says, has “fortress-like balance sheet.” If you’d rather just buy a bunch of banks, consider SPDR S&P Bank ETF (KBE, $29.87); the exchange-traded fund lost 7.2% on June 24.

Despite a sharp rise in the dollar, gold, which normally moves in the opposite direction of the greenback, jumped more than 4% on June 24, to $1,320 an ounce. But investors seeking safety may be running in the wrong direction, says Wells Fargo’s commodities strategist, John LaForge. “Gold is a chameleon,” he says. “Sometimes it reflects the direction of inflation or interest rates, sometimes it reflects fear. Today it’s clearly fear, and as long as that fear is there gold will do well.” LaForge, though, is not bullish on gold long-term, and he thinks investors should take advantage of the Brexit rally to lighten up on the yellow metal.

Investors needn’t be in a rush to bargain hunt–buying in over the course of weeks or months makes sense, while watching out for red flags, such as other countries deciding to bolt from the European Union, France in particular. A “Frexit” could be even bigger than Brexit in its impact on markets, says Schwab’s Kleintop.

(Source: TCA)