Note from Our CIO: Brexit

Sometimes what works best over the long-term looks positively stupid in the short-term. Our investment strategy — based on owning nearly all of the public companies in the world — comes with a cost. The “cost of diversification” is that there can and will be periods of time when U.S. companies perform significantly better than non-U.S. companies. We bear this cost because a truly global portfolio has been rewarded more than an exclusively U.S. portfolio over time. But this has not been the case since the eve of the financial crisis eight years ago.

Since the beginning of 2008, which marked the peak of the world’s stock markets before they tumbled into the financial crisis, European companies have lost 1.1% per year through May 2016. ¹Stock returns in the United Kingdom have lost 0.4% per year over the same period. These returns were overshadowed by the returns in the United States, which were 6.6% per year. My hypothesis is that the capital markets and the economy in the United States are freer and more supportive of human innovation and productivity – the vital ingredients needed for a recovery from the financial crisis – than in the European nations, as reflected by the respective performance of stocks on the two continents (see Table 1).

Table 1. Annualized stock performance from January 2008 through May 2016

Of course, the returns from all these markets look great if we’re measuring from the bottom of the financial crisis in March 2009. But that would not be a measure of the resilience of markets over a full business cycle, nor of the benefit (or cost) of global diversification. Rather, what we are measuring in Table 1 is the annualized return from the high point of the market right before the crash, all the way through the bottom of the crash and then the subsequent (so called) recovery. Have company values grown from the last market high at the beginning of 2008? Certainly that has been the case in the U.S., but clearly not in Europe.

On June 23, the United Kingdom voted to free itself from the European Union. Referred to as “Brexit”, I’m cautiously optimistic it could, in due course of time, mark the beginning of increased entrepreneurship, job creation and freer international trade in the U.K. Ultimately, these forces could lead to more wealth creation and higher standards of living, which are the fuel of higher stock returns. My caution here is that Brexit may be used for purposes of nationalism and isolationism, which are, at least in the long run, destructive forces for long-term wealth creation and stock performance.

This is no small event. The United Kingdom is the fifth largest economy in the world, and it, not China, is the largest investor in the U.S. It will no longer be forced to live under crushing external tariffs imposed by the European Union, which, to name just one of many examples, deters African farmers from exporting their produce to the U.K., perpetuating poverty in Africa and raising the prices of those goods in the U.K. Innovation in the U.K. becomes a real possibility, which is difficult in the EU with 28 member states having to agree on everything. Markus Breyer, director general of BusinessEurope has said “Technological progress is often hindered or almost impossible in Europe.”

This is not to say that the Abacus Investment Committee was waiting for a major historical event such as “Brexit”, to mark the turn-around in the performance of our international investments. We believe that all of the nearly 60 countries we invest in have sufficient commitment to free market principles to foster wealth creation. Nor is this to say that we now know our U.K. investments will deliver high returns over the next several years.

The recent vote by the citizens of the U.K. to leave the EU and become a more free economy may increase the likelihood of wealth creation and high stock returns in the U.K. It also suggests that we might expect reforms within the European Union, which was originally created with the noble purpose of ensuring the free flow of capital, labor, goods and services across the borders of its member states. An optimistic global investor can hope for a shift in the EU toward its original purpose, further increasing the likelihood of wealth creation and better stock performance across the pond and throughout Europe.

¹European stock returns are represented by the Morgan Stanley Capital International (MSCI) European Index (net div.), while United Kingdom stock returns are represented by the MSCI United Kingdom Index (net div.). Both index returns are expressed in United States dollars. For stock returns in the United States, we use the Standard & Poors 500 Index. All indexes are total return indexes, reflecting both price appreciation and dividends (reinvested).

Abacus Wealth Partners is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Actual performance of client portfolios may differ materially due to the timing related to additional client deposits or withdrawals and the actual deployment and investment of a client portfolio, the reinvestment of dividends, the length of time various positions are held, the client’s objectives and restrictions, and fees and expenses incurred by any specific individual portfolio.

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This is not an offer to sell any type of security, and there is no investment currently available through Abacus, which would allow someone to invest in JUMO World. Abacus Wealth Partners is the General Partner of Abacus Impact Fund 2013, LP, a fund of funds that ultimately has an interest in JUMO World. The information presented in the “Impact Investment Profile” is to provide additional qualitative reporting to Abacus clients who own Abacus Impact Fund 2013, LP, as well as to help educate Abacus clients about impact investing.

This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell this security. This newsletter contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Information was based on sources we deem to be reliable, but we make no representations as to its accuracy. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Information related to the firm’s performance is based on pure model portfolios only and is net of fees. Certain clients may have holdings that deviate from the model and as such individual client performance may be different than the results presented herein.

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