What Did You Learn From Brexit?

Given the Brexit brouhaha, how did your investments hold up?
Barry Ritholtz
Washington Post, July 24 2016




“It is easy to confuse day-to-day noise with actual and significant signals. If you are merely reacting to the latest market action, then what you have is not a plan — you have an instinctual, fear-driven reaction, and it’s the makings of a disaster.”

— Me, the weekend after Brexit



So that was Brexit.

How did your portfolio hold up during the tumult and news coverage and all of the other assorted nonsense that took place?

Did you panic? Did you sell out after the vote?

Lots of folks did. They bailed into the 5 to 10 percent sell-off immediately following Britain’s 51 percent vote to leave the European Union.

It took the markets all of a long weekend to figure out that Brexit is the Brits’ problem; it’s going to be their recession, their diplomatic headache, their trade problems.

We had other ideas here in the U.S. After that brief post-Brexit wobble, investors came to realize that this is not a global event but a zero-sum game — London’s losses are going to be New York’s, Geneva’s and Hong Kong’s gains. And Britain’s losses will probably be Germany’s, France’s and Switzerland’s gains.

Meanwhile, the post-Brexit action has pushed the Standard and Poor’s 500-stock index and the Dow Jones industrial average to all-time highs.

But enough about failing empires filled with low-information voters hellbent on self-destruction. Let’s talk about you: What did you learn from Brexit?

Here are a few key takeaways. Ignore them at your peril!

Investing based on macro events is nearly impossible: This wasn’t some comet falling out of the sky or a random act of terror. It was a well-anticipated event, covered by the media, with billions of dollars at stake, not only from investors but also businesses, property owners, and even the British bookies.

Despite the close race, it seems that very few people (other than a few randomly lucky traders) managed to position themselves correctly for both the immediate sell-off and the subsequent snapback rally and new record highs. A coin flip alone should have had about half of the crowd getting this right. That so many more did not is quite telling as to human behavior.

Why? It requires two skill sets that many (or most) investors lack: second-level thinking and nearly perfect timing.

The great bond investor Howard Marks of Oaktree Capital, whose quarterly memos have become essential reading on Wall Street, described this last year. In a memo titled “It’s not easy,” Marks describes the things the second-level thinker must take into account:

“What is the range of likely future outcomes?

“Which outcome do I think will occur?

“What’s the probability I’m right?

“What does the consensus think?

“How does my expectation differ from the consensus?

“How does the current price for the asset comport with the consensus view of the future, and with mine?

“Is the consensus psychology that’s incorporated in the price too bullish or bearish? What will happen to the asset’s price if the consensus turns out to be right, and what if I’m right?”

Most investors hardly considered that the “stay” camp might lose the vote. They never really considered a list of possibilities as Marks advocates. No wonder they were not prepared.

You cannot time the market. Assume you are a second-level thinker, capable of determining the possible and probable outcomes. Once you have that down, you must perfectly time your exits and entrances. You have to have made the binary bet in advance to sell equities — and buy bonds and gold (despite how close the vote was); then you had to repurchase equities into the teeth of the sell-off despite what looked like more ugliness to come. That is always much harder, emotionally, to do in real time than it looks. Then you had to decide when to kick that trade for a profit, despite the market rising nearly every day since.

Long-term investors pay attention to short-term distractions at their own risk. If you are a long-term investor — think decades or longer — why would you even care about short-term events like Brexit? Look at long-term charts of U.S. equities, and seminal events like the John F. Kennedy assassination, Nixon’s resignation, the 1987 market crash, and the Sept. 11, 2001, terror attacks are hardly visible.

In the long scheme of history, whether Britain stays as a partner with the E.U. is unlikely to have much impact on your holdings. Your focus on news flow should be commensurate with the duration of your holdings. Unless you are short-term trader, why are you wasting your limited attention and bandwidth on short-term noise?

Diversification may be boring, but it works. A globally diversified, low-cost, index-driven, asset-allocation model is your best bet for securing long-term returns. But it is probably the worst way to invest if you want something sexy to talk about at cocktail parties or summer barbecues.Waxing eloquent about compounding modest gains continuously over time is not the sort of chatter that will get you invited to the dais at the next Friars club roast. But it will help investors do much better than if left to their own devices of stock-picking and market-timing.

You cannot control events, but you can control your behavior.This is fairly obvious, but it’s often ignored. What the Fed is going to do, how the Brits will vote, what happens in the markets — all of it is beyond your control.

What is within your control is how you plan for future events — regardless of what they may bring. Even more important is how you decide to respond.

Nobody knows anything. The experts stink, the pollsters are out of their league, the pundits are, well, mostly idiots, and even the so-called prediction markets can’t predict. Even the stock and currency markets anticipated that the people would choose to remain.People know little and can predict even less. If your investment strategy involves you making the right guess about what comes next, you are doomed to failure. Take heed of the lessons Mr. Market provides. It’s the only way you are going to be able to become a decent investor.~~~Ritholtz is chief investment officer of Ritholtz Wealth Management.


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