JUNE 24, 2016: Comments on the British exit from the European Union
By Bernard R. Horn, Jr., President and Portfolio Manager of Polaris Capital
There are a couple of points that we think may help to explain the exit vote (BREXIT). We were expecting a vote to “remain” but felt a vote to leave would ultimately be a healthy development to an increasingly problematic union. We expected a vote to remain on the theory that in federalist systems the economic and social benefits appear more tangible than the costs borne to collectively support those programs. The social benefits, in the form of transfer payments, tend to be dispersed broadly so that most member states see some benefits. However, the costs of such systems are often greater than what any individual state would spend on their own and as the federal, or in this case the European Union (EU), controls an ever larger budget there becomes a question of balance. In elections regarding membership, most voters tend to be reluctant to give up benefits that they perceive someone else is paying for and so votes tend to be in favor of staying with whatever union provides the benefits. This was the case with the Scottish vote last year. In the EU, however, there appears to be more separation among those member states that are benefitting from membership and those that are paying for it. The financial crises in Portugal, Greece, Spain and Italy pointed this out. The continuing resistance and, in fact defiance, in Greece to take the hard medicine like that taken by Ireland has drawn further scrutiny on the payee/payor difference.
The refugee crisis has also added to this concern. This week I was speaking with a number of Greek companies and I asked the chief economist of a large Greek bank what economic impact the refugees are having on the economy. Specifically, I made the observation that there must be significant transport and logistics systems in place to stimulate and support the flow of people into Europe and that Greece seems to be a focal point in the effort. I asked if the underground operators of such a system were keeping the cash in the Greek economy or if it was flowing out to Russian or other operators. The response was that the money was staying in the country. What the economist said next was more relevant. He indicated Greece is receiving about EUR 700M to support building shelters and other infrastructure for the refugees. Not only are Greek operators most likely profiting from and creating a flow of refugees but the EU payments represents about 0.5% of GDP to the distressed Greek economy. So Greece is highly incented to benefit in this politically charged issue, in contrast to the negative headlines and cost burdens ascribed to refugees who move on to other countries. So it appears the refugee crisis not only focused greater attention on the payee/payor inequalities but the negative refugee headlines during the Brexit vote may well have boosted support to leave.
Although less politically visible, many companies across sectors/industries have expressed concerns about the over-reaching regulations from Brussels. While this is not a populous issue, it highlights the fact that many companies now believe the regulatory burden of their home country compounded by Brussels is impairing their ability to be competitive in the global economy.
There are many arguments why an economic union has overall benefits; these are well documented in economic theory. However, as the BREXIT vote demonstrates, the political mood has changed in Europe. While the benefits of a union are understood by economists, the perception that they accrue to some but are paid by others means the social contracts have to be rethought. We think the exit vote will ultimately be healthy for the European Union. The original treaties negotiated that led to the union have developed unintended consequences that may no longer work for all members. It is logical for states outside the union to desire to join and earn the right of membership. There must also be the risk that violating terms of the union means an exit for non-compliance. If no rule exists, other European Union “payors” may decide leave. Europe must re-think the political contracts, as all politics must adapt to economic reality. We are optimistic Europe will go through a period of adjustment as it renegotiates with a separate United Kingdom and in this process it will have the opportunity to improve upon the overall project.
At Polaris, we believe that the significant decline in share prices is unwarranted. Certain share price declines in some of our portfolio companies, like the British homebuilders, present a very good opportunity to add to our positions.
We frequently comment that during any given year there will be very negative headlines that will cause stock prices to go down. We have advised clients to expect such events. After the British vote to leave the European Union (BREXIT), many investors have succumbed to the normal human emotions of fear and flight that have led to a dramatic sell-off in markets worldwide. We encourage investors to think differently in such downturns. This decline may serve as a good opportunity to rebalance your investments or take some of the sidelined cash (that we advised clients to keep aside for just such an opportunity) and use it to buy at what appears to be very good valuation levels.
A PDF copy of this note is available.
This blog was penned by Bernard R. Horn, Jr. in June 2016. Mr. Horn founded Polaris Capital (a leading Boston-based global and international value equity firm) in April 1995 to expand his existing client base dating to the early 1980s. Mr. Horn’s pure global value philosophy combines investment technology with traditional fundamental research. His 30+ year track record exceeds most current competitors in length and has produced admirable risk-adjusted returns since inception.
IMPORTANT INFORMATION: The views in this article were those of Bernard Horn Jr. as of the article’s publication date (June 24, 2016) and may be subject to change. Information, particularly facts and figures, are dated and in many cases outdated. Views and opinions of Bernard Horn Jr. expressed herein do not necessarily state or reflect those of Polaris Capital Management, and are not nor shall be used for advertising or product endorsement purposes. Polaris Capital is an investment adviser registered with the Securities and Exchange Commission. For more information about Polaris, please contact us at (617) 951-1365 or via email to Client Service.
