Brexit: What Happens Next?

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Photo credit: frankieleon

Well, they did it. Brits have voted to leave the European Union. Now what?

I wrote last month that Brexit could take a wrecking ball to your portfolio. And judging by the carnage in the markets last night and this morning, that wasn’t an understatement. The pound sterling was down as much as 12% in overnight trading, and stock markets around the world plummeted.

So the question now is: what happens next… and how will it affect your portfolio?

I’ll start with the controversial statement that I think Britain herself will get out of this relatively unscathed. Yes, the pound is in freefall. But considering that central banks all around the world are competitively cheapening their currencies as a way of spurring exports, I don’t really see that as a bad thing.

If anything, it will probably boost tourism… and might encourage even more foreign buying of real estate.

Yes, there is a good chance that Britain has at least a mild recession. Companies that were planning to expand in the UK as their European beachhead might put those plans on hold for a while.

But as Britain’s new relationship with the EU starts to take shape, I think something close to the status quo will reassert itself. Europe has no viable financial capital other than London… which has managed to maintain its position, even though the UK never adopted the euro.

So, that’s the good news. The UK won’t be sliding off into the north Atlantic.

Now for the bad news…

While Britain will probably be fine once the dust settles, I can’t say the same about the European Union.

Europe is losing its biggest military and diplomatic power, the world’s fifth largest economy and one of its biggest free-market champions.

Said another way: Europe without Britain is a nightmare. It’s all of the headache and regulation of an overbearing central government but without the push for free trade… which was frankly the only thing that made the enterprise worth doing to begin with.

But that’s a long-term issue. What happens now?

Things are moving fast, but this is the scenario I worry about: while England and Wales voted strongly for Brexit, Scotland voted overwhelmingly to stay in Europe. So Scotland will probably have another independence referendum within the next year that will actually pass this time.

And that’s where things can really go south.

Catalonia has been agitating for independence from Spain for a while… as has the Basque Country. Will they see Scotland leave and then seize their moment?

Then what? What happens to the euro when one of its largest member states splits up?

Remember back in 2010 when the financial world went mad over whether Spain and Italy would remain in the Eurozone? Six years later, we’re right back where we started.

ECB President Mario Draghi said he’d do “whatever it takes” to save the Eurozone. But will “whatever it takes” be enough? Or is this the beginning of the end for the euro as a currency?

In the immediate short term, all of this points to one thing: uncertainty. And markets hate uncertainty.

It may take days… or weeks… for the market to handicap what the real risk is here. And that means we’re likely to see major volatility. There will be major down days… and major up days. It will be enough to give you whiplash.

Think back to 2008, when Lehman Brothers cratered. We had some of the worst single-day selloffs in history. But we also had some of the largest single-day rallies in history.

Now, I’m not necessarily expecting another 2008. I think it’s very likely that the central banks will collectively dump liquidity into the currency and bond markets to keep the bottom from completely falling out. But I do expect a lot of wild trading without much in the way of a trend. So bottom line, for the next few weeks, tread carefully.

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