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Please Brexit at the Next Vote

On June 23rd the United Kingdom voted to leave the EU. Prior to the vote polls indicated the populace would vote to remain in the EU but we were all reminded why polls come out with a margin of error. The outcome of the vote caused a degree of panic across markets as people digested the news.

How much actual damage will occur from the Brexit is yet to be seen. Once a member country has notified the EU of its intent to leave they have two years to negotiate the details of the withdrawal…there is still some time before anything will be technically different. But the preparation for withdrawal will be costly to the UK and companies operating in the UK. Over 50% of the UK’s trade goes to countries in the European Union. New trade agreements will be required with each individual country and then businesses will have to comply with each individual agreement. This will increase costs and uncertainties over the next couple of years.

Longer-term consequences are harder to see. Most economists and other outspoken public officials seem to be of the opinion that this will be bad for the UK and for the EU. In reality, it is impossible to know. Not only could there be unknown negative consequences but there could also be unknown positive consequences. For example, British officials have already begun dialogue with Asian and other emerging countries to negotiate new trade agreements. Those officials will have more opportunity to negotiate agreements beneficial to England as opposed to subordinating their interests to that of the EU. A pivot towards trading more with emerging economies that are less debt laden and more room for economic expansion than EU member nations may prove to be a long term boon to the their economy. Only time and decisions will tell.

Where the greatest risk appears to be in this scenario is any contagion effect the Brexit will have on other nations leaving the EU. There are already political parties in several EU member nations pushing for an EU referendum. If viewpoint begins to steamroll – as it did in the UK – than there could be a lot of political and therefor economic turmoil in the EU. We will maintain a close eye on the situation to see if changes to risk warrant adjustments to portfolio positions.

China

In our last commentary we wrote the following:

The Chinese market and economy have made a lot of headlines over the past year. The Shanghai Exchange experienced massive volatility in 2015 and the resultant conversation of the financial pundits was that the Chinese economy was headed for a hard landing. We have never quite understood the general consensus of the financial world towards China. They have painted a picture of a country laden with debt, lower economic growth prospects, and highly overpriced stock markets (sounds familiar). But to every one of these arguments there exists fundamental misunderstandings about China. In the interest of brevity, let’s examine just one…overpriced stock markets.

Let’s consider another one of these misunderstandings…lower economic growth prospects.

How Much Slower is Lower?

China has experienced unprecedented economic growth over the last 2 decades. Looking back over the last 20 years the annual Gross Domestic Product growth rate has ranged from 8% to over 14% on an annual basis and never experienced an economic contaction during that period. In terms of size, total GDP has grown from just under $1 trillion in 1996 to over almost $10 trillion today. That’s an average annual growth rate of over 13%.

What many economic and market pundits find alarming is the trend-line of growth. Looking at the below chart you can easily point out a downward shift in annual percentage GDP growth. Growth peaked in 2007 at around 14% and has steadily declined since. It currently sits in the 6.5% to 7% range and the International Monetary Fund estimates growth to be 6.3% in 2016 and 6% in 2017.

 

There is no arguing with the numbers and facts – Chinese economic growth as a percentage of GDP is slowing – but we find the worry surrounding this situation to be puzzling for a couple reasons. First, answer this….which would you rather have? 12% of $350,000 or 6% of $1,000,000. I don’t know about you but I want to sign up for the 2nd deal…its $18,000 more. Now, add a few zeros to the equation and you are looking at the GDP growth of China. While the economy is experiencing lower growth on a relative basis it’s current total $ growth still out-paces the higher % growth rate of 5-10 years ago.

Secondly, when did a 6% growth rate become a bad thing? Since 1970, the US has experienced greater than 6% GDP growth in one year (1984) and the US Federal reserve is projecting a growth rate of 2.2% for the US in 2016 and slightly less in 2017, which we feel is optimistic. Admittedly, comparing developed US growth to developing China growth is not an apples to apples comparison but it does help put into perspective reasonable expectations. In the slow growth era the global economy is currently in 6% growth is nothing to shake a stick at.

Over the next several years we do expect a slight continued slowing or – at best – a stabilizing of Chinese economic growth but we do not think it warrants as much concern or worry as many people are giving it. As the numbers above show, even with a slower growth rate than it was once accomplishing China is still experiencing substantial growth at a rate unseen in developed economies and higher than most developing economies. With a growing middle class and an economy in the midst of shifting from being export driven to being consumer driven we believe there is plenty of opportunity for prudent active management to identify and take advantage of growth opportunities.

Conclusion

The Brexit vote does cast another shadow over global growth prospects but only time will tell how long a shadow it casts. We are constantly looking out for risks and also looking for pockets of opportunities where we feel the potential return is commensurate with risk. We feel we have identified some areas but also remain cautious as the global economy continues to work through the challenging environment it has created for itself. We will continue to invest in areas where we see value and the greatest potential for long-term growth.
Blake

Past performance is not a guarantee of future earnings. Asset allocation does not assure a profit or protect against loss in a declining market. Blake A. Stanley, CFP® is an Investment Advisor Representative of Legacy Advisory Group, LLC a Registered Investment Advisory Firm.

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