Like many others, I am trying to absorb and process yesterday’s decision by British voters to leave the EU. While the story will continue to unfold over the next several years, it is not too early to be thinking about the current implications. While it certainly came as a surprise, for anyone who has lived in England, as I did for 15 years, it was not a complete shock. While they may have benefited from economic integration, at the end of the day the country remains an island and therefore is insular by definition– when Brits talk about Europe they are talking about a foreign country not themselves.

To briefly summarize our views, I think it is useful to categorize the effects of the British withdrawal both chronologically and by area of impact.

In the short term, it is clear that financial markets are going to be volatile and likely marked by falling equity prices. We have already seen multi percentage point declines in stock prices around the world, with Europe and the UK being particularly hard hit, though for the time being, the US has not suffered as much, which makes good sense as we are not as directly impacted. Overall, these declines are not a huge surprise, as markets had been expecting the measure to fail, and had actually gone up several percentage points last week in anticipation of a remain vote. As we all know, markets hate uncertainty and this is certainly terra incognito. However, these kind of knee jerk declines are often short term in nature and can quickly reverse themselves. As I write this, Japan, which at one point was down the most of any major market, is showing a 3% bounce in its futures.

Fortunately, policy makers do have some room to maneuver and are starting to make the expected moves in terms of a more stimulative monetary policy, etc. The result of this should be to further postpone interest rate increases in the US, with any increase in US rates likely pushed back until towards the end of the year. “Lower for longer”, as they say. In Europe, the Central Bank was active in the debt markets on Friday, ensuring orderly conditions and ample liquidity. However, after a number of rounds of monetary easing over the past five years, policy makers’ flexibility has diminished, and will be more of a short term emollient than a long term panacea. Ultimately, markets are likely to re-calibrate downwards. Given their current relatively high valuations, a correction should not come as a complete surprise, particularly in light of the relative lack of other significant macro-economic news. In our view, as long as market psychology does not succumb to its post global financial crisis tendency to see recessions everywhere, the current falls should be limited.

Medium term, attention will be more focused on the economic effects of Brexit. Here, I think markets will be prone to exaggerate the direct impact. The reality is that the UK’s economy is just not that important anymore, accounting for less than 4% of global GDP. Not surprisingly, the expected economic impact will fall most heavily on nearby economies. Most projections are for Brexit to cause UK GDP to fall something on the order of 1% over the next 12 months. The GDP of Europe, which is the UK’s largest trading partner (exports to Europe account for about half of the total– roughly 13% of GDP), is expected to decline by about half that amount, or 0.5%. In Asia, estimates of the direct impact on GDP are less than 0.1%. One mitigating effect for the UK will be the fall in the value of the pound, which should be stimulative, especially for exporters. The US should escape the brunt of the burden and may even benefit from increased capital flows and a flight to quality.

Longer term, the key questions will surround the impact of the British departure on the EU. Many of the issues are essentially political. Some of these are unknowable and we will just have to wait for the dust to settle. For example, how will the process unfold as the UK seeks to disengage itself from Europe? This is designed to be a two-year process, but clearly it will be important that negotiations proceed in an orderly and rational way, with minimal rancor. Unfortunately, current comments emanating from Europe indicate that there are some who would like to make an example of London during the disengagement process. Will there continue to be some sort of preferential trade treatment for the UK? Could it join the European Economic Area like Sweden? To some extent, the ultimate outcome is binary. Will this cause the EU to start unraveling, as isolationist pressure builds up to follow the UK lead, or will European integration move forward more rapidly without a reluctant partner?

Over time, perhaps the most important implication for the global economy will be how it reacts to these uncertainties. Markets, as noted, hate uncertainty, but uncertainty can also take a toll on the real economy. There is ample evidence that capital expenditures, and long-term investments in improving productivity may decline if businesses do not feel comfortable with the economic environment. This in turn, has implications for shareholders, who stand to benefit less if potential gains in earnings are truncated because of insufficient investment in R&D, plants and equipment. While we are still recovering from the hangover from the previous financial crisis, the last thing we need is another macro-economic shock, and the potential for contagion that it implies. However, short-term volatility in the markets notwithstanding, I do not believe that Brexit rises to that level of importance. While the impact on the UK will be non trivial, unless it causes market perceptions of recessionary potential to escalate dramatically, or the EU to break apart, the global effect should not be significant. Longer term, the investment environment may suffer, but given the multiplicity of factors involved, the scale of any UK related disturbance is probably going to be minor.

Meanwhile, back in the real world, I am happy to be able to report to those of you who are clients that we have zero exposure to UK stocks, so the direct effect of the vote will be negligible. Further, the diversity of our portfolios across geography and asset classes should minimize the negative impact. As is often the case, the Brits seem to offer the best advice: stay calm and carry on. As always, I welcome any comments or criticisms, and would be delighted to try to answer any questions.