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A single word explains why financial markets everywhere are nosediving

Sam Ro
Managing Editor
(Image: Wikimedia Commons)

British voters stunned the world as they voted to leave the European Union.

The results were followed by the worst crash in the British pound against the US dollar ever. At one point, the pound had fallen to a 30-year low of around $1.32. Meanwhile, stocks markets around the world are plummeting, with the UK's FTSE 100 down 4.5%, Germany's Dax down 7.1%, and Japan's Nikkei down 7.9%. Dow futures are down 540 points, or 3% from Thursday's levels. Investors and traders everywhere are losing money today.

And so begins what could be a two-year long, very complicated process of renogitiating trade deals and other policies as the UK aims to decouple from the EU.

Then again, policy experts also note that British leaders could also quickly turn around a new deal that would be more amenable to the British voters seeking to leave, causing them to switch their votes.

The bottom line is we just don't know what's next. So, in the wake of the results of this EU referendum, experts everywhere are repeating one word: uncertainty.

Experts agree: it's all about uncertainty

Here are some quotes from Wall Street's top economists and investment strategists:

"As we have stressed repeatedly, this will lead to an intensified uncertainty shock that will hurt growth," Societe Generale's Michala Marcussen said in a note to clients.

"We see protracted political and economic uncertainty," Morgan Stanley's Jacob Nell said in a report titled "Out into the Unknown."

"Although the uncertainty of the UK’s EU membership vote is now behind us, the uncertainty of how this will proceed is now a real issue," ING's Rob Carnell said. "Messy politics in the UK, and an uncertain reaction from the EU in terms of how to treat a departing member, all make for a period of heightened risk aversion."

"Even for countries with a relatively low trade exposure, heightened volatility and uncertainty are likely to lead to weaker growth through delayed investment and consumer spending and weaker employment," HSBC's Karen Ward said.

"Markets’ default view had been that, despite the discontent over the adjustment costs of globalisation in many western nations, populations generally still would choose the status quo over uncertainty," Barclays' Marvin Barth said in a note title "A Leap into Uncertainty."

Barth nails the characterization. For the most part, people prefer a bad situation over an uncertain situation. Not only could an uncertain situation turn out to be worse than the status quo, it prevents consumers and businesses from preparing and planning.

Uncertainty is at the core of what investors call the risk premium. Generally speaking, it relates to uncertainty tied to whether or not an investment will be successful. Will the business you're investing in generate a certain level of profits? Will the government bond your buying payout at maturity? The greater the uncertainty, the more investors demand in the form of returns. (Read more about this here, here, and here.)

In the financial markets, uncertainty is higher today than it was before Britain's EU referendum. And so, all of the financial assets out there must be priced lower as buyers now demand a cheaper price to take on this increased level of risk.

On the other side of all this, it's possible to see some very unfavorable deals come out of the UK and EU. While these deals might be bad for everybody's economy, at least they will lead to more certainty. And that increased sense of certainty may actually send markets higher.


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The UK may have commited 'an act of economic self-harm with global ramifications'

One chart captures the night of insanity as the Brexit vote counts trickled in

Credit Suisse: The US stock market won't be safe from a 'full Brexit'