It finally happened. After a long, contentious campaign, voters in the United Kingdom decided to leave the European Union once and for all. "Brexit," as it's popularly known, is no longer a risk for the markets, but a reality.
Ahead of the referendum, the average of polls from Pollster showed the "remain" camp having a half-a-percent lead over the "leave" camp―45.8% to 45.3%. While indicating a close race, bullish investors were hopeful that the polls were correct in predicting that the U.K. would stay in the EU.
Stocks rallied broadly on Thursday, while safe-haven government bonds and gold sold off.
With the race so tight leading into the referendum, perhaps investors should have seen it coming. The final tally was close―just as the polls predicted―but it was the “Leave” camp that edged out the “Remain” camp, with 52% of voters in favor of leaving and 48% in favor of staying.
Today the markets reacted violently to the news.
Long Exit Process To Begin
The vote in favor of Brexit now begins a messy divorce process between the U.K. and the EU, which may last two years. In addition to untangling itself from the EU, the U.K. must come up with new trade deals and relationships with the union.
A report from the International Monetary Fund said that "ratification of a new deal would require unanimous consent of all EU member governments, making agreements subject to considerable political risks."
Additionally, "these processes and their eventual outcomes could well remain unresolved for years, weighing heavily on investment and economic sentiment during the interim and depressing output," wrote the IMF.
Best & Worst Case Scenarios
In the most optimistic scenario, the U.K. takes a modest short-term economic hit, and most of the damage is contained within the country.
On the other hand, more pessimistic forecasts call for much deeper economic pain, including a housing crash, significant reductions in trade, investment and a widespread recession.
Some analysts take it a step further and predict that the Brexit vote could embolden nationalist parties in other European countries, leading to more exits from the EU, and an eventual catastrophic breakup of the union.
Europe Stocks Walloped
Unsure of which post-Brexit scenario plays out, today investors took no chances, as they dumped their risky assets and loaded up on safe havens.
It comes as no surprise that the biggest losers today were ETFs tied to Europe. The Vanguard FTSE Europe ETF (VGK | A-97) was down 11.3%, while the WisdomTree Europe Hedged Equity Fund (HEDJ | B-47) was down 8.8%.
At the same time, the largest fund tied specifically to the U.K., the iShares MSCI United Kingdom ETF (EWU | A-91), dropped 12% on the session.
Interestingly, excluding currency fluctuations, U.K. stocks notably outperformed their European counterparts. The iShares Currency Hedged MSCI United Kingdom ETF (HEWU | F-40) was only down 3.7%.
HEWU hedges its currency exposure, helping it avoid the affects of today's wild swings in the foreign exchange markets. The British pound was down 8.1% against the U.S. dollar after earlier reaching a 31-year low of 1.32 to the greenback.
The euro was down a more modest 2.4% against the dollar to 1.11, after earlier reaching its lowest level since March.