On "Brexit" & Market Declines {PartI}

I had a call Monday afternoon from a client who was concerned that Thursday's vote in Great Britain on whether to stay or remain in the European Union could cause a significant decline in the markets or possibly a stock market crash.  She said many people in her office expressed the same concern.  I recently emailed my thoughts on this to her and I'm sharing it now with my readers today and tomorrow.  Today I'll address my thoughts on a "Brexit" and the markets.  Tomorrow I'll share what I believe investors should instead focus on.  Here's Part I:

"I think it is less probable tomorrow that Great Britain will vote to leave the European Union {Brexit}.  The stock market seems to believe that as well.  It has experienced a nice rally in the past few days.  I also believe if the consensus thinking {Britain staying in the EU} turns out to be incorrect then there is a greater likelihood that stocks could experience a near term pullback.  Experience would suggest such a pullback could be as mild as a few percentage points to as much as 10% if coupled with other bad news.  Of course anything is possible but I think a steep decline, which I'll define as a pullback in a very short period of time greater than 15-20%, seems to be a low probability event.  The reason I think such a decline is not the most likely outcome is that markets have had the opportunity to at least partially discount the possibility of Brexit.   Rapid market declines usually occur when an unforseen event or unexpected negative information suddenly catches investors "offsides".  That is such negative news causes investors to suddenly realize their exposure to stocks  is too great.  The September 11, 2001 attacks and their aftermath are a textbook example of an event happening out of the blue that investors could not have foreseen   The negative impact drove them almost significantly cut their exposure to stocks when trading next occurred, often regardless of cost.    

Brexit is a binary event. It's results will be "leave" or "remain".  Probability suggests large institutional investors have worked out the possibility that Britain leaves and they've reviewed its impact on their  portfolios.  Again I will stress I'm not saying stocks won't experience a decline if "leave" comes out on top.  Any result is possible. However, this result has already occurred to people and to some extent already in the markets.  We will only be able to know how much a "leave" is baked into stocks if it happens by how much, if any, markets decline.  In that vein, it is also possible that investors will take profits in the event "remain" wins as markets have seen a nice rally in the past few days.  "Buy the rumor and sell the news" is an old market saying and indicates that sometime speculators take their chances after market declines, buying shares into negative news events and then sell out when positive news breaks.  Binary events can be crapshoots in terms of how markets will behave."