Wealth Dimensions Group Newsletter
July 2016
In the second quarter of 2016, Great
Britain’s so-called “Brexit” vote, a
national referendum on continued
participation in the European Union,
sparked an abrupt bout of global market
volatility in June. Equities across the
globe slumped after the Brits surprised
the world by voting to leave the EU,
some by double digits. In a matter of
days, this market turmoil disappeared as quickly as it came and
most markets ended the quarter in positive territory.
For the quarter, large company US stocks, as measured by the
S&P 500 were up 2.46%, while the small cap Russell 2000 ended
up 3.79%. Overseas developed markets had farther to recover
after the Brexit vote, but regained most of the June downturn
with the MSCI EAFE finishing down 1.19%. Emerging markets
managed a slight gain with MSCI Emerging Markets index up
.80%. Bonds had another positive quarter
as evidenced by the Barclays US Aggregate
up 2.21%, once again defying those
challenging the wisdom of holding fixed
income.
It seemed like yesterday when we dedicated
an entire commentary to the European
Union and the eurozone (EU members
that also share a common currency), but
it was actually in 2011. At the time, markets were reacting to
a combination of dilemmas challenging the very essence of the
16-year-old experiment of a common currency known as the
euro and the viability of the entire union. Now that Britain’s
vote has called attention to these matters again, we thought
it would be useful to remind our readers of the role the EU and
the eurozone play on the global stage and what the future might
hold for both Britain and the EU post Brexit.
A Brief History of the Union
Most Americans have a limited understanding of all the moving
parts in European monetary and fiscal systems, which is
unfortunate given the important role Europe plays in the global
economic landscape. A complete explanation of these entities
is far beyond the scope of this letter, but we will provide you
with a basic understanding of the EU, its interrelationship with
the eurozone and the context in which the British made their
decision to leave the Union.
The European Union (EU) is a partnership where member states
cooperate on a wide range of economic, social and political
issues. The concept of this union began after World War II,
initially by six Western European countries - Belgium, France,
Germany, Italy, the Netherlands and Luxembourg, with the
intent to promote peace, security and economic development.
Over time, membership in the union has grown to 28 member
states sharing markets with coordinated trade policies. As this
partnership developed, the desire for more integration has taken
shape with 22 of the EU members agreeing to free movement
between member states without passports (the Schengen
agreement) and 19 member states sharing a common currency
(the eurozone). In addition, the EU has a whole host of treaties
and agreements with regard to foreign and security policies to
help unify the union, many with roots in fostering peace and
prosperity after World War II.
The European Union has multiple governing bodies that
oversee different aspects of its operations. Brussels is the de
facto capital of the union and is the site of much of the official
business of the EU. The European Commission is the executive
body of the EU and is responsible for proposing legislation,
implementing decisions, upholding the Union’s treaties and the
general day-to-day running of the Union. The European Council,
made up of member states, enforces legislation throughout the
union and seeks to improve cooperation between governments.
The Council is the more powerful of the two and the one that
dictates most of the important decisions. Within this council
is a subset made up of the original six members, referred to as
the “EU-6”, which tends to rule the roost on most matters. In
addition to these governing bodies, the European Parliament
serves as a public forum of the EU debating important issues and
overseeing the activities of the Council and Commission.
Achieve What Matters Most
The European Union
Member Countries
The State of the Union
There is general consensus that the European Union has been
a success story for greater Europe having provided political
stability and economic prosperity. If you include Great Britain,
the EU is the largest single trading block in the world and the
largest trading partner of both the US and China. However,
the Union and the eurozone have and will continue to face
myriad challenges both economically and politically, as
evidenced by Britain’s decision to leave the union. This is a
significant event, as Great Britain is the first country to vote
to leave the EU. While Algeria (1962) and Greenland (1985)
both voted to leave, technically, they left the EU predecessor,
the European Economic Community (EEC). The Great Britain
referendum turnout was 71.8%, with more than 30 million
people voting, making it the highest turnout in a UK-wide
vote since the 1992 general election. That said, the vote was
52%-48%, leaving the country almost equally divided on the
issues surrounding the decision to leave.
2
The Debate
The root cause of contention in this union is the difficulty in trying
to become a true single market while maintaining some semblance
of economic and political sovereignty. As the EU has developed,
there have been various degrees of commitment to its broad ideals.
Some members support a more loose association, yet others seek
a far more integrated, unified union. While they all recognize the
value of the union, these differences in member states become
abundantly apparent in times of economic or political duress.
Economically, eurozone-related issues seem to be ground zero for
this contention. Before the launch of the euro in 1999, worldrenowned economist and Nobel laureate, Milton Friedman
encouraged the eurozone to abandon the idea of a single currency
platform. If they chose to proceed, he predicted that the eurozone
would not survive its first major economic crisis. Friedman
recognized what may prove to be a fatal flaw of eurozone, which
is, without flexible exchange rates of currency, imbalances will be
created as individual member states have limited mechanisms to
deal with their own economic cycles.
The problem arises because each member state has full control of
fiscal decisions such as tax rates, entitlements, and government
spending. In addition, they each have differing societal views on
It is to that end that we shall also recognize different levels of ambition amongst Member States
when it comes to the project of European integration. While not stepping back from what we have
achieved, we have to find better ways of dealing with these different levels of ambition so as to
ensure that Europe delivers better on the expectations of all European citizens.
- EU-6 response to UK vote
saving, consumption and work ethic. Collectively, these dynamics
have consequences that create differing economic outcomes and
cause imbalances between members with no monetary means to
balance them. For instance, low workplace productivity, unrealistic
entitlements, and lax tax enforcement in Greece have resulted in
skyrocketing deficits and stifling debt that has placed it on the brink
of insolvency. Germany, on the other hand, has far tighter fiscal
controls, a more robust economic infrastructure, high personal
savings and is able to take advantage of an artificially low currency.
If Germany had its own currency, it could not be as competitive
globally, because its currency would rise in value. Germany is helped
and Greece is hurt by sharing the same currency. As these imbalances
arise, it tears at the fabric of the union and causes countries like
the UK to question its union bonds.
Politically, it has been equally challenging to form political bonds
with countries that at times have been bitter enemies. Further, no
member state wants to relinquish its sovereignty to Brussels or any
other governing body. Over time, there has been a notable rise in
support of populist, nationalist, anti-establishment political
sentiment across the EU, not unlike some of the rhetoric coming
from US politicians of late. The combination of economic woes
stemming from the financial crisis in 2008, structural and social
dynamics, and the recent wave of disruptive migration from the
Middle East and Africa have empowered so called “euroskeptics”
to push for less control from Brussels and more self-determination
in each member state. The UK’s decision to leave the union was
influenced by both economic and political dynamics, but in the end
proponents of Brexit focused on self-determination, especially with
regard to migration, outnumbered those voting to remain.
What’s Next for Brexit?
While the UK has officially voted to leave the EU, nothing will
really happen until they trigger Article 50 of the Treaty of
Lisbon, which establishes the protocol to disengage from the
EU. Pundits estimate that once this is triggered, it will take
two years to complete. In the meantime, leaders in the EU are
divided between those who want to punish the UK as a warning
to others who might consider the same path and those who
want to reform the union to be a more viable and cohesive
entity. We mentioned the EU-6, a powerful subset of the
governing body of the EU. Shortly after the Brexit vote, they
made the following statement in response to the vote which
hints to a more sympathetic EU on Brexit:
It is to that end that we shall also recognize different levels of
ambition amongst Member States when it comes to the project
of European integration. While not stepping back from what
we have achieved, we have to find better ways of dealing with
these different levels of ambition so as to ensure that Europe
delivers better on the expectations of all European citizens.
To Brexit or Remain?
To give you an idea of the complexity
of this matter, consider the following
list of issues that remain whether
Britain voted to Brexit or Remain:
• Migration - The challenges of
the onslaught of migrants
from Africa and the Middle East.
• Economic/Monetary Stress - Greece remains under
financial duress from EU-imposed austerity as its economy
remains in a deep recession. Spain and Portugal are
experiencing some of the same economic problems with
no currency mechanisms to mitigate them under the
economic structure of the eurozone.
• Sovereignty - Countries like Poland and Hungary’s
continued struggles against EU mandates that disrupt
their internal affairs.
• Monetary Policy - The European Central Bank manipulating
interest rates in an effort to prop up the weaker nation
states while trying to figure out viable long-term solutions
to the EU’s structural problems.
• Russia - Russia and NATO remain at odds over a number
of geopolitical issues in the region, creating growing angst
and forcing already stretched governments to boost
defense spending.
• Terrorism - ISIS or ISIS-inspired terrorists continuing to
plot attacks like the ones in Paris, Brussels, and Instanbul.
• “Frexit”, “Italeave” et al. - Many countries are experiencing
the same political debate about whether they should
stay in the EU, with new anti-EU political parties gaining
power across Europe.
• The Italian Banking Crisis - Much like Greece, Italy has
not been able to adapt to the financial rigors of the EU
and now finds itself in the midst of a full-scale banking
crisis providing new challenges for the European Central
Bank (ECB).
As you can see, the EU has a lot
of work to do in reforming itself
for sustainability. Perhaps the
Brexit will be the catalyst for
positive change.
3
What’s an Investor to Do?
History has shown that it is impossible to predict the magnitude
and timing of market reactions to economic and political
events, underscoring the long-term benefit of diversification.
Over the last five years, large company US stocks and investment
grade bonds have been bright spots of global markets as the
Federal Reserve embarked on massive monetary stimulus and
structural reform. Global investors responded by pouring money
into the US markets as a safe haven. As a result of capital inflows,
US stock valuations and comparative market performance have
become stretched relative to their global peers and a rebound
in the opposite direction appears inevitable.
The current
levels of relative valuation have occurred several times over
the past 50 years and each time it begs the question, Why
diversify?. We don’t know when this will peak, but a study of
history demonstrates it is at these times when diversification has
proven its greatest value. Global investors will seek out the most
favorable risk/reward opportunities, and as the US markets are
expensive relative to other markets, money will flow out and
other markets will become the performance leaders. There
As global economic and political events unfold, there is a
tendency to believe that events can be foreseen or their impact
can be accurately predicted. Academic research clearly debunks
this belief, yet demonstrates that they do offer opportunity. Our
disciplined long-term investment methodology takes advantage
of these performance divergences by measuring risk-adjusted
returns and the behavior of each asset class relative to the
others to maximize return while reducing volatility over time.
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1986
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is no doubt that challenges in the Eurozone have played a role
in holding back the performance of their markets, but those
same challenges bring about change that unlocks the value.
2016
2016
YEARS
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As we celebrate our 30-year anniversary,
we want to thank you for your continued confidence in our services.
WEALTH DIMENSIONS GROUP, LTD.
Investment indices are provided by Standard and Poors, Russell Investments and MSCI. Performance of these indices is not indicative of any particular investment. The indices
are unmanaged and individuals cannot invest directly in any index. The Barclays U.S. Aggregate Bond Index is comprised of a variety of taxable bonds, and is used as a measure,
or benchmark, of the US bond market. No strategy including diversification can guarantee a profit in a down market. Past performance does not guarantee future results.
Information provided has been prepared from sources and data we believe to be accurate, but we make no representation as to its accuracy or completeness. Data and information is
general in nature and not meant as specific to any particular situation. As such, you should not act on this information and should seek advice based on your particular circumstances.
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Please be advised that this material is not intended as legal or tax advice. Accordingly, any tax information provided in this material is not intended and cannot be used by any
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