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6 Ways To Profit From Three Post-Brexit Scenarios

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Emotions defeated experts and on June 23, the UK voted 52% to 48% to leave the European Union (EU). Investors should consider three scenarios -- global dissolution, minor UK economic disruption, and UK decline, global stability -- and six ways to profit from them.

The UK -- which conducts $575 billion of annual trade with the rest of the EU -- now begins a multi-year process of renegotiating how it will interact with the $13.6 trillion single EU market.

Investors -- surprisingly if you looked at the polls -- were shocked by the UK's decision. As of 8AM ET on June 24, the FTSE 100 was down 3.3%, the pound had fallen 8.6% relative to the dollar, crude oil fell 4.5% and the S&P 500 futures were down 5%.

Why did the UK vote for Brexit? My guess is that emotions -- British anger and frustration over giving up perceived sovereignty to the EU over immigration and other issues -- overpowered rationality -- the desire to preserve the strength of the UK economy.

Brexit yields vast uncertainty.

And that means investors should consider different scenarios. Here are three that come to mind:

  • Global dissolution. Under this scenario, Brexit marks the beginning of the end for globalization. The EU falls apart as other countries withdraw from the EU and a wave of nationalism and ethnic rage grips the world -- most notably resulting in the election of Donald Trump. The U.S. rips up its trade agreements and stops making payment on its debts. Financial markets collapse.
  • Minor UK economic disruption. Here, the UK spends the next three years making changes to its contracts with the rest of the EU and ultimately decides to just move on and work with the EU under existing WTO rules -- resulting in a temporary slowdown in the UK economy that ultimately sets the country up for a recovery.
  • UK decline, global stability. Under this scenario, the rest of the EU decides to push through tariff-heavy terms for the UK's continued trading with the EU. The UK grudgingly accepts these terms and suffers a significant slowdown in economic growth which leads companies and workers out of the UK. The British Treasury estimated that Brexit would cause tis GDP to fall by 3.5%, throwing half a million people out of work and cut housing prices by 10% according to the New York Times. The EU's tough stance dissuades other countries from leaving the EU.

I don't know whether these are the right scenarios or their probabilities. But I am leaning towards the second scenario.

Global Dissolution

  • Buy gold. People who think the world is going to fall apart tend to buy gold. It's unclear how you could buy a loaf of bread with a bar of gold -- but if the world is falling apart, people don't concern themselves with such details.
  • Buy shares of gun manufacturers. Similarly, under global dissolution everyone will need a big arsenal of guns to defend themselves against marauding militias roaming the earth. This is great news for companies that make guns.

Minor UK economic disruption

  • Buy the pound. If the UK's economy slows down a bit and then works with the EU via WTO rules, its growth and financial markets will recover nicely. Therefore buying the pound at today's lower price will pay off handsomely.
  • Bet on a rising FTSE 100. Under this same logic, the FTSE 100 should enjoy a nice rise after the uncertainty is resolved.

UK Decline, Global Stability

  • Short the pound. If the EU extracts a high price from the UK for its continued participation, the pound will weaken and likely still has further to fall.
  • Bet on decline in shares of UK-based grocers, retailers, and lodging providers. "Chain operators like Whitbread Plc, lodging groups like InterContinental Hotels Group Plc and retailers like J Sainsbury Plc are all heavily dependent on European workers: almost three-quarters of workers in the hospitality sector in London are foreign-born," according to Bloomberg. These companies will lose access to inexpensive labor from EU immigration and will end up needing to pay higher salaries to UK-based workers -- trimming their margins. Under this scenario, you could profit from a bet that shares in such companies will fall.

After living through the inexplicable January 2016 plunge, the gyrations surrounding the possibility of Grexit and its debt negotiations, the May 2010 flash crash, and other fear-inducing events, I am inclined not to react at all to Brexit.

Over the long run, stocks -- nicely represented by low-cost index funds -- always seem to outperform other financial instruments. And perhaps a panicked world will conclude that buying U.S. stocks is the best way to protect their wealth. I will keep buying them.