On June 23rd, the citizens on the United Kingdom voted decisively (51.9%) to leave the European Union, despite a campaign to remain in the EU led by the UK’s top politicians. Markets reacted sharply to the news: the pound sterling lost about 10% and is trading near its lowest level in 30 years. Global equities plunged on the heels of the result before partially recovering in recent days – notably the FTSE (UK) and the S&P 500 fully recovered to pre-Brexit levels.
The secession of Britain from the EU will likely prove disruptive to the European and global economies, although to what extent is not yet clear. Make no mistake, though – for some time now economic fundamentals have been weak, and the global equity valuation relative to earnings was already very high, the highest since 2000 in several markets.
Real year-over-year GDP growth is shown on this chart, for the US (the red line) and for the Euro area (the blue line). Note that after the severe global recession of 2008-09, the Euro area suffered another economic contraction in 2012. Despite recent recovery, Europe’s growth is still far from robust at around 1.5%, compared with 2% in the US (which has itself slowed in the past three quarters). Economic growth below potential, profit pressures, and extremely high valuation for European stock indexes account for European market (IEV, -11.9% YoY) underperformance compared with the US.
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