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Welcome to Brexit

Written by Gerald E Gasber, CFP®, CIMA®, QPFC.

Yesterday's vote by the British electorate to end its 43-year membership in the European Union seems to have taken just about everybody by surprise, but the aftermath could not have been more predictable. The uncertainty of how, exactly, Europe and Britain will manage a complex divorce over the coming decade sent global markets reeling. London's blue chip index, the Financial Times Stock Exchange 100, lost 4.4% of its value in one day, while Germany's DAX market lost more than 7%. The British pound sterling has been crushed (down 14% against the yen, 10% against the dollar).

Compared to the global markets, the reaction among traders on U.S. exchanges seems muted; down roughly 3.5% at the close, though nobody knows if that's the extent of the fall or just the beginning.

The important thing to understand is that the current market disruptions represent an emotional roller coaster; an immediate panic reaction to what is likely to be a very long-term, drawn out accommodation between the UK and Europe. Given these circumstances it is probably premature to assume that German companies are 7% less valuable today than they were before the vote, or that the pound sterling has suddenly become a second-rate currency. When the dust finally settles, people may well find that this panicky Brexit aftermath was a buying opportunity, rather than a time to sell. Those who sold may come to realize they were suckered once again by panic masquerading as an assessment of real damage to the companies they were invested in.

What happens next for Britain and its former partners on the continent? Let's start with what will NOT happen. Unlike other European nations, Britain will not have to start printing a new currency. When the UK entered the EU, it chose to retain the British pound—that that, of course, will continue. Stores and businesses will continue accepting euros.

On the trade and regulatory side, the actual split is still years away. One of the things you might not be hearing in the breathless coverage in the press is that the British electorate's vote is actually not legally binding. It will not be unless and until the British government formally notifies the European Union of its intention to leave under Article 50 of the Treaty of Lisbon—known as the "exit clause." If that happens, Article 50 sets forth a two-year period of negotiations, subject to extension, between the exiting country and the remaining union. Since British Prime Minister David Cameron has officially resigned his post and called for a new election, that clock probably won't start ticking until the British people decide on their next leader.

After notification, attorneys in Whitehall and Brussels would begin negotiating, piece by piece, a new trade relationship, including tariffs, how open the UK borders will be for travel, and a variety of hot button immigration issues. Estimates vary, but nobody seems to think the process will take less than five years to complete, and current arrangements will stay in place until new ones are agreed upon. So, for the foreseeable future, despite what you read, the UK is still part of the Eurozone.

So, how should investment clients of Gasber Financial Advisors, Inc. respond to Thursday's events and subsequent market reactions? For an answer we turned to Dimensional Fund Advisors, our long term partner in managing client portfolios.

"While there has been much speculation leading up to and since the vote, many of the longer-term implications of the referendum remain unclear, as the process for negotiating what a UK exit may look like are just beginning.

Dimensional has nearly 35 years of experience managing portfolios, including during periods of uncertainty and heightened volatility. We monitor market events—including their impact on trading and trade settlement—very closely and consider the implications of new information as it comes to light. We are paying close attention to market mechanisms and they appear to be functioning well. Our investment philosophy and process have withstood many trying times and we remain committed.

We urge caution in allowing market movements to impact long-term asset allocation. Long-term investors recognize that risks and uncertainty are ever present in markets. A drop in prices is generally due to lower expectations of cash flows, higher discount rates, or both. In some cases, a drop is also due to investors demanding liquidity. In the current situation, some investors and economists may expect lower cash flows due to possible trade barriers that may not be implemented [Emphasis added]. Higher discount rates may be occurring due to uncertainty about changes in the economic landscape and regulations. We have seen markets increase discount rates in times of uncertainty before, resulting in lower prices and increased expected returns. However, it is difficult to know when good outcomes will materialize in the future. By attempting to time the right moment to invest or redeem, one risks not enjoying the potential benefits of such materializations. Many of those who exit the markets miss the recoveries [Emphasis added]. What we have often seen in the past is that investors who remained in well-diversified portfolios were rewarded over time.

The UK will have up to two years to negotiate a withdrawal, during which time it remains subject to EU treaties and laws. Any potential operational changes depend on what path the UK and EU decide to take. Leading up to and since the vote, we have worked with our counterparties, including custodians, brokers, and dealers, regarding potential operational implications resulting from the UK's leaving the EU.

Dimensional remains committed to helping our clients in the UK, other parts of Europe, and around the world have a good investment experience. "

In conclusion, the important thing for everybody to remember is that many market participants are being driven by fear due to uncertainty and predictions based on incomplete data. What is being described by many in the media as an event is really a long process. Nobody knows exactly how the long-term prospects of Britain, the EU or American companies doing business across the Atlantic will be impacted by Brexit, but it would be unwise to assume the worst so quickly after the vote.

Relevant Quotes

"The difficulty first in predicting events, but even the greater challenge of predicting how other investors will react to these events. The most reliable way for investors to accumulate and preserve wealth is to adopt and maintain a broadly diversified strategy. Diversified across companies, across industries, across countries, and across currencies. This idea that we should dip and dart and reduce our exposure to risky assets based on some prediction that we our others might make more often than not lead to frustration and failure to capture the rates of return that capital markets have to offer."

- Weston Wellington, Vice President, Dimensional
- From: The Financial Crisis in Greece at https://www.dimensional.com/v/?v=1_rustqjut&p=b10a130d-eaed-4b90-a69a-882bf2c3cf15&f=false&d=true

"Europe, the U.K., the U.S. and the rest of the world will adapt to the new reality. As for the markets, they discount the future and will absorb and reflect the implications of Brexit relatively quickly. So it's best not to extrapolate what happens today or next week very far into the future. In the end, broad diversification coupled with adequate cash and bond reserves will carry us through any short-term dislocation we may observe as a result of Brexiting Brits."
- Dave Yeske, Managing Partner of Yeske Buie, Inc.

"Each year investors end up getting a variety of curveballs tossed their way. Last year it was China, the year before Greece and this year Brexit. While this may permanently impact the Brits in many ways, a few years from now it will merely be a footnote in stock market history."
- Brent R. Brodeski, CEO of Savant Capital Management

Sources:

https://www.yahoo.com/news/brexit-shows-global-desire-throw-142925862.html

https://www.washingtonpost.com/opinions/global-opinions/after-brexit-what-will-and-wont-happen/2016/06/24/c9f7a2f6-39f1-11e6-8f7c-d4c723a2becb_story.html

http://www.businessinsider.com/global-market-brexit-reaction-2016-6

www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html#ixzz4CVixCz25

http://www.ft.com/cms/s/0/f0c4f432-371d-11e6-9a05-82a9b15a8ee7.html?ftcamp=traffic/partner/brexit/dianomi/row/auddev#axzz4CVide1Sz

http://www.newser.com/story/227149/brexit-now-what-happens-welcome-to-article-50.html

 

Brexit and Your Portfolio

Written by Gerry Gasber.

Investors worldwide are concerned about the possibility of a "Brexit": the potential exit of "Britain" (to be precise, the United Kingdom) from the European Union.

A Brexit would represent a significant crack in the foundation of the EU. Economists believe it might produce a recession in the U.K., and when one economy slumps, there are always regional and international consequences.1

Right now, Wall Street has its eyes on a date: June 23. On that day, U.K. voters will head to the polls for a referendum on whether or not to leave the EU. A June 15 poll in The Times showed 46% of respondents intending to vote "leave," 39% intending to vote "remain," and 15% either undecided or not voting. In a new Guardian/ICM poll, 53% of respondents indicated they would vote for a Brexit.2,3

If approved, a Brexit would not happen for at least two years – but if the U.K. electorate does approve it, global markets will undoubtedly see some turbulence. Reassuringly, the European Central Bank and the Bank of England have pledged to provide additional liquidity to European financial markets if a "leave" vote rattles investor confidence.4,5

The effect on Wall Street may be short-lived. For the past several months, American investors have focused their attention on earnings, oil prices, the Federal Reserve's possible policy decisions, and fundamental economic indicators like consumer spending and hiring. While a Brexit would be major news, it may prove to be only a temporary distraction for U.S. investors. 5

So be prepared for volatility, but avoid making rash decisions. If U.K. voters call for a Brexit, Wall Street might suffer a short-term hiccup – but you are investing for the long term, and short-term phenomena should not lead you to make hasty or ill-advised investment decisions. At moments like these, staying the course is often the best course.

1 - bloomberg.com/news/articles/2016-05-23/brexit-may-spark-yearlong-recession-cost-jobs-treasury-says [5/23/16]

2 - reuters.com/article/us-britain-eu-poll-idUSKCN0YZ2FY [6/15/16]

3 - cnbc.com/2016/06/13/short-term-fears-aside-brexit-wont-have-big-impact-on-us-market-experts.html [6/13/16]

4 - bbc.com/news/uk-politics-32810887 [6/14/16]

5 - reuters.com/article/us-britain-eu-ecb-idUSKCN0Z01NP [6/14/16]

Big Vote in Europe

Written by Bob Veres & Gerald E Gasber, CFP®, CIMA®, QPFC.

The big question in Europe this year is how the British people will vote on June 23. Will they vote to leave the European Union (what's being called the "Brexit") or decide to continue to be part of the 28-nation economic alliance?

What's at stake? It's hard to know, exactly. Great Britain already maintains its own currency, separate from the euro, so the vote will be about whether the country continues to pay into the EU budget and adhere to the Eurozone's regulations. Norway is also living outside the EU, yet it contributes to the budget, adheres to the regulations and seems to get most of the benefits of membership—and thereby offers a way for Britain to exit and still maintain all the trappings of membership. The uncertainty over the seven years that would be required to transition out of membership would be over how, exactly, a new relationship would be structured.

The Eurozone is suffering from high unemployment, low economic growth and a disparity between the richer (UK, Germany, Scandinavia) and poorer (Greece, Spain) nations. All European Union members are governed by policies created by the European Commission and the European parliament, and subject to the dispute resolution powers of the European Court of Justice. British voters might decide they don't like the shared sovereignty and ties to the economic problems.

Naturally, there is a lot of lobbying on both sides in the run-up to the vote. Economists seem to be uniformly against a Brexit, pointing out the obvious: that it would be hard for London to continue its role as the financial capital of Europe if its nation is not actually a part of the European Union. They point out that, unlike Greece, Britain already controls its own currency, and it is not a part of the passport-free zone, which is shorthand for having control over its own policies in regard to the Middle Eastern refugee crisis.

Those in favor of Brexit say that Britain would be freer to enter into trade deals with other countries (think: China) than it is today, and of course there is a lot of nationalist sentiment about reducing foreign influence over British affairs.

Who will win? The most recent polls show 46% of British voters will cast a ballot to leave the EU, vs. 44% who will vote to remain—and 10% who say they don't know how they'll vote. With a little less than a month from the actual Brexit election, there appears to be plenty of time for either side to continue pressing their case.

Sources:

http://www.ft.com/intl/cms/s/2/70d0bfd8-d1b3-11e5-831d-09f7778e7377.html#axzz40tXOLR6p

http://www.ft.com/intl/cms/s/2/e7b2d4d4-daea-11e5-98fd-06d75973fe09.html#axzz48O9tGx46

http://www.economist.com/node/21697253

http://www.express.co.uk/news/politics/668624/EU-referendum-ICM-poll-UK-on-course-for-Brexit-Europe-Day

 

The Best Ways to Buy Happiness

Written by Bob Veres & Gerald E Gasber, CFP®, CIMA®, QPFC.

We all know that money can't buy you happiness, right? As it turns out, this is not exactly true.

A recent study by University of Michigan economists Betsey Stevenson and Justin Wolfers, examining data from more than 150 countries using World Bank data, has shed new light on the interaction between happiness and the size of your bank account. Their first conclusion: the more money you have, the happier you tend to be, regardless of where you are on the income spectrum. They concluded that multi-millionaires don't think of themselves as "rich."

However, there do seem to be income levels where a person's happiness can be increased faster than others. Princeton University economist Angus Deaton has found that peoples' day-to-day happiness level rises until they reach about $75,000 in income—a point where a person can comfortably afford the basic necessities of life without worrying where his or her next meal is going to come from. After that, this type of happiness levels off.

In fact, a report in Psychological Science magazine found that the wealthier people were, the less likely they were to savor positive experiences in their lives. Another study found that lottery winners tended to be less impressed by life's simple pleasures than people who experienced no windfall. Once you've had a chance to drink the finest French wines, fly in a private jet and watch the Super Bowl from a box seat, a sunny day after a week of rain doesn't produce quite the same jolt of happiness it used to. The additional money tended to have a cancelling effect on day-to-day happiness.

It's another kind of happiness, which focuses on something the researchers call "life assessment," that continues to rise at all levels of wealth. The more money people have, the more they feel like they have a better life, possibly (Deaton hypothesizes) because they feel like they're outcompeting their peers.

Is there any way to more efficiently buy happiness with money? A study by the Chicago Booth School of Business found that people experienced more happiness if they spent money on others than when the money was spent on themselves. Treating someone else—or, more broadly, charitable activities—are among the most powerful financial enhancements to personal happiness.

Other research has shown that you get more happiness for your buck if you buy experiences rather than things. An epic trip to Paris, or a weekend at a bed and breakfast near the cost, can be more enduringly pleasure-inducing than buying a new watch or necklace. The watch or necklace quickly become a routine part of your environment, contributing nothing to happiness. But your travel experience can be shared with others and reminisced about.

Finally, you can buy time with money—decreasing your daily commute by moving closer to work, hiring somebody to help around the house, hiring an assistant to clear your desk—all giving you more leisure time to pursue your interests. With the free time, take music lessons or learn to dance—and you'll be happier than somebody with millions more than you have.

Sources:

http://fortune.com/2013/05/01/proof-that-money-does-in-fact-buy-happiness/

http://www.scientificamerican.com/article/can-money-buy-happiness/

http://www.nydailynews.com/life-style/health/money-buy-happiness-article-1.1458890

 

Under Water in the Caribbean

Written by Bob Veres & Gerald E Gasber, CFP®, CIMA®, QPFC.

By all accounts, Puerto Rico is a beautiful, sunny place to visit, especially in the Winter. But it's hard to fathom how this U.S. island territory of 3.5 million people could have racked up $70 billion in public debt—roughly $20,000 per citizen, which happens to be almost exactly the population's average yearly income. Now that Puerto Rican bonds are trading at 20-50 cents on the dollar, a lot of people are starting to wonder what happened.

On Monday, for the third time, Puerto Rico defaulted on its debt, paying the interest due on bonds issued by the Government Development Bank, but nothing on the principal—effectively defaulting on $370 million. Previous defaults include $143 million worth of appropriation bonds from Puerto Rico's Public Finance Corp. and rum-tax securities issued by the territory's Infrastructure Financing Authority. An additional $1.9 billion payment is due July 1, and nobody seems to be very optimistic that Puerto Rico will come through with that money either.

The story is a familiar one. There was a lot of investor demand for Puerto Rican bonds, because they're exempt from federal and state income tax in all 50 states—meaning residents in Wyoming can buy Wyoming bonds, or Puerto Rican bonds, and have the interest exempt from state taxation. The territory met the demand by issuing debt by 18 different public debt issuers. In recent years, interest rates on these bonds crept higher as it became clearer that the territory would not be able to meet its obligations, making the bonds attractive to mutual funds that wanted to offer high yields to investors who didn't understand the default risks.

Would a broader Puerto Rican default affect your portfolio or the municipal bond market generally? Probably not. Most of the bonds have been repurchased for pennies on the dollar by opportunistic speculators, mostly hedge funds, some of whom recently traded $900 million of face amount Puerto Rican bonds for 47 cents on the dollar. A similar agreement retired $33 million in debt held by a group of credit unions. The territorial government has proposed that holders of its general obligation bonds accept 74 cents on the dollar, and Congress is discussing the possibility of allowing the territory to file for bankruptcy under Chapter 9—currently an option for U.S. states, but not for Puerto Rico.

But investors in some of those aforementioned mutual funds could be greatly impacted. Most municipal bond funds were reluctant to touch Puerto Rican paper with the proverbial ten-foot pole, knowing that the risk of default made positive returns problematic. But load fund company Oppenheimer loaded up on Puerto Rican debt through its Rochester line of funds, and the Franklin Double Tax-Free Income Fund holds the endangered paper as well. Both companies are now lobbying hard against any deal, but the most likely outcome is that they will become poster children for the dangers of recklessly chasing yields, particularly as the handwriting has been on the wall for years.

Sources

http://www.investmentnews.com/article/20160503/FREE/160509984/oppenheimerfunds-among-the-biggest-bulls-on-puerto-ricos-municipal?utm_content=buffer2c06f&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer

http://finance.yahoo.com/news/puerto-rico-investors-push-competing-000124750.html;_ylt=AwrXgSJeASlXl1AAOXjQtDMD;_ylu=X3oDMTByNDZ0aWFxBGNvbG8DZ3ExBHBvcwM2BHZ0aWQDBHNlYwNzcg--

http://www.census.gov/newsroom/press-releases/2014/cb14-17.html

https://in.finance.yahoo.com/news/puerto-rico-defaults-422-mn-060600955.html

http://money.cnn.com/2016/05/02/investing/puerto-rico-default-may-1/index.html

http://www.bloomberg.com/news/articles/2016-05-01/puerto-rico-will-default-on-government-development-bank-debt

https://in.finance.yahoo.com/news/puerto-rico-defaults-422-mn-060600955.html