Wow. That escalated quickly. After years of head fakes and empty threats by members of the EU, investors had been lulled into complacency a la Public Enemy – Don’t Believe The Hype. Whoops.
But now that Britain has let the genie out of the bottle, that false sense of security has been shattered. And as a result, investors are fleeing risk assets in favor of safety. They would be wise to remember that short-term comfort often comes at a high long-term expense.
Defensive, high-quality equities are now trading at extremes last seen during the 2008-2009 Financial Crisis and the 2011-2012 European Crisis (chart below). This presents investors with quite the quandary:
- Option one: Pay up for comfort and buy “safe” assets at a hefty premium. This is the “easy” and obvious decision today. But paying too a high price can turn even high-quality assets into low-quality investments. High quality assets can decline just as much when that quality premium normalizes.
- Option two: Embrace uncertainty and buy more cyclical assets at lower prices. This never feels good and almost always results in greater short-term volatility. But buying lower-quality or more cyclical assets at a cheap enough price can provide even the most conservative investors with a large enough margin of safety.
We don’t know what the answer is today. And we won’t know what the right choice is for a while. But when the entire European banking sector falls double-digits in a day (and more than 20% in USD), it certainly feels like one should hold their nose (and maybe close their eyes) and buy uncertainty. We put some cash to work on Friday. Time will tell.