There's been a whole lot of talk about 'Brexit' lately, but what exactly is it?
What is Brexit?
You may have noticed a striking similarity between the word 'Brexit' and 'Grexit'. Put simply, Brexit describes the possibility that Britain will withdraw from the European Union, just as Grexit described the possibility that Greece would exit the Eurozone and return to its previous currency, the Drachma.
Most of us can remember the turmoil that Grexit caused in 2015 and in the years prior as the country struggled to make interest and loan repayments on its mountainous pile of debts. Grexit dominated the news headlines and threw the market into a frenzy due to the uncertainty of what would happen next.
The cause is different when it comes to Britain, but the effect has been much the same. It seems the British people are eager to regain control of their own country, ending the central control by Brussels. Some argue that this could boost the British economy – ridding itself of the drag from the rest of Europe – while an exit from the union would also reduce the threat to Britain's sovereignty.
The in/out referendum for Brexit will take place on Thursday, 23 June.
Why is it a concern?
As was the case with Grexit, there are plenty of concerns regarding Britain's potential exit from the European Union that are causing angst among investors.
Indeed, the Reserve Bank of Australia even noted in yesterday's monetary policy announcement that its "attention is now turning to some particular event risks" which could well include Brexit. The RBA kept interest rates on hold at 1.75% for June, but further rate cuts are still expected – perhaps before the end of 2016.
Part of the uncertainty relates to how the British economy will respond if it does exit the union. It would be separating itself from its largest trade market, whilst also weakening the union itself at a time where Europe is already struggling in the aftermath of the Global Financial Crisis.
Of course, that in itself raises concerns about how that could impact the global economy. Any uncertainty could lead the US Federal Reserve to hold off on any further interest rate hikes for even longer, which could put an upward pressure on the Australian dollar and force the RBA to cut rates further. It is also unclear how it could impact global trade, which is perhaps one of the reasons behind the jitters experienced by the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) this year.
What are the odds of Brexit occurring?
Despite the debacle, Greece didn't leave the Eurozone. Likewise, there is no certainty that Britain will leave the European Union, even though some groups are rallying hard for that to happen.
Some polls show that a leave vote is unlikely to occur. According to The Week, Betfair has the probability of the UK leaving at 28% (up from 19% at the end of May). But others, including a poll from The Independent, show a rather close count that could really go either way:
Regardless of what happens, there is no doubt that the uncertainty related to Brexit is having an impact on the confidence of investors around the world, and will likely continue to do so over the coming weeks.
What should investors do?
What investors must remember, however, is that this is by no means the first time we've had to face uncertainty. Grexit is one recent example, together with the oil crisis, the tension between Russia and the Ukraine on the Crimean Peninsula and the U.S. debt ceiling.
The point is, investors are constantly faced with uncertain situations. Some investors frequently give in to those fears, taking their profits off the table at the first sign of anxiety, while others remain calm and focus on the bigger picture, remembering that they have survived – and even prospered – through previous situations.
Of course, that doesn't mean investors should buy just any old stock. Some companies are more vulnerable to specific situations than others, including those which generate much of their earnings in the Eurozone. If Brexit does occur, then those companies could be hit hard, together with cyclical businesses that even include names like Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd. (ASX: NAB).
The most important things for investors to do is ensure they know the businesses they are invested in, and ensure they are comfortable owning those businesses over the long term.
It's also important to remain calm if the market does take a turn for the worst. In fact, if Brexit does occur and the market does take a hit, it could be a great opportunity for long-term investors to pick up some high-quality businesses at discounted share prices.
