We Didn’t Foresee Brexit, and it Didn’t Matter

June, 2016

Based on the torrent of emailed “analyses” we have received, wealth managers appear to have universally recommended inaction both before (because they did not expect it) and after Brexit (because they did not know what to do).  Despite one of the greatest one-day worldwide equity market selloffs in history, their advice was to take no action.  Apparently, no matter what the event or the depths to which equity indices sink, their advice has always been the same: stay the course.  The strategy of holding positions in the hope of eventually recouping losses has worked.  But hope is not a plan, and one day, hope will run out.

Unlike most previous financial crises, the Brexit saga arrives in an era of systemic risks across world economies and financial markets.  With systemic risk, the idea of “diversifying” across equity markets for protection fails as investors flee most markets during severe turmoil.  And given the unbridled expansion of debt and money since the 2008 financial crisis, we believe systemic risks abound.

Will Brexit be the catalyst to unleash such systemic risks and drive down worldwide equity markets?  We do not know, but it is possible.  With equity valuations in the developing world near record-high levels, stock market analyst John Hussman believes a negative change to investor sentiment alone may trigger a downturn.  Many other experts likewise believe Brexit marks an important psychological turning point:

This is the worst period I recall since I’ve been in public service.  There’s nothing like it, including the crisis. (recalling the stock market “Black Monday” crash in 1987)
- Alan Greenspan, former Federal Reserve Chairman

This is big because it’s at the time when the central banks have lost their power . . . It’s the beginning of the end of central bank power and it’s the beginning of the end of the European Union.
- Gerald Celente, publisher of the Trends Journal

There’s a bear market in confidence in market manipulators, policy makers, central bankers and politicians broadly.  There’s a bear market in confidence in planning.
- Jeff Gundlach, Chief Executive Officer of Doubleline Capital

Investors may be able to protect themselves from systemic risk by owning investments which fundamentally differ from traditional equities. Investments such as farmland, residential rental real estate, secured private lending, and precious metals may not only protect the value of portfolios, but may also allow investors to profit from financial crises.  Even long-term U.S. Treasury bonds may help (temporarily) as investors seek “safe havens.”  The year-to-date financial performance of some of these investment categories is especially insightful (through June 28, 2016 according to Morningstar).

If Brexit does not act as a catalyst, plenty of other events may trigger a worldwide, severe, and prolonged downturn in financial markets.  It could be the collapse of a European bank, a recession in the U.S., or a currency crisis in Asia.  It could be these, or to quote former Defense Secretary Donald Rumsfeld, one of many “unknown unknowns.”  It is difficult to predict which snowflake starts the avalanche.

We admit we did not foresee Britain leaving the European Union, but it did not matter as WindRock builds portfolios to withstand systemic risk regardless as to the catalyst.  Given today’s world of insignificant or negative interest rates, record debt levels, and unprecedented money printing, all investors should consider systemic risk and, unlike the advice of some wealth managers, take action.