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Brexited - Market Update

| June 24, 2016
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Market Update

Commentary:

 

In last week’s update, I wrote the following:

 

The market then turned its attention to a referendum vote on June 23rd regarding whether the UK will remain in the European Union.  Should Britain exit (a.k.a “Brexit”) the EU, a realignment of Europe’s financial sector will occur.  The uncertainty over this vote has spooked the market and most stock indices fell this week.  The EU is a group of 28 European countries that have agreed to abide by certain rules to facilitate trade and commerce.  Polls suggest the vote will be close and volatility up or down is likely though the voting results.

 

After polling shifted back and forth in recent weeks, the market boldly shifted to “risk on” Thursday anticipating a “stay” vote and Thursday saw notable gains in most major indices.  The world was then shocked late into Friday morning as the “exit” vote narrowly won in the end and “risk off” became the mantra Friday with most major indices off by more than -3%.  Perceived safe haven investments like US Government Bonds and Gold rallied.

 

I believe the decision for the UK to exit the European Union will have the following consequences:

 

  • Short term volatility at the shocking outcome of the vote – the banking sector has been hit particularly hard
  • Major short term fluctuations in world currency markets – the US dollar and the Japanese Yen rallied as safe haven currencies while the Euro and Sterling fell
  • An increase in the possibility of a recession, particularly in the UK and potentially Europe – companies operating in the UK may hold off on capital expenditures and lay off workers pending new trade agreements
  • Political instability as the UK replaces Prime Minister David Cameron and the possibility that other countries consider exiting the EU.
  • Over the next 2 years or more, the UK will need to renegotiate all of its many trade agreements, but at least it already has its own currency

 

Ultimately, I believe the British exit of the EU will not have much of a long term impact on the US

 

  • I believe the earnings of US companies are the primary driver of US stock prices and that markets are currently reacting emotionally to Brexit, especially in the US
  • The US economy continues to chug along at a very modest pace – US employment and consumer spending are strong, wages and inflation are starting to rise, manufacturing is improving
  • The main headwinds to US earnings growth are abating: low oil prices, a strong US dollar, and at the moment Fed uncertainty
  • The odds of the US Federal reserve raising short term interest rates at the July meeting is now 0 (see chart below) with the odds of a rate decrease now standing at 7.2%

 

 

Oil prices continue to lose momentum.  Oil closed at $47.68 per barrel Friday.  Cheaper oil is good for consumers but bad for oil companies which have been a drag on corporate earnings.

 

 

The US dollar spiked Friday as a safe haven currency but the trend continues downward. As the dollar falls, US exporters benefit.

 

 

Here is a 1 year chart of the NASDAQ.  This index consists mostly of technology companies and remains in a choppy downtrend that has unfolded over the last year.  The NASDAQ is now down -7.33% over the last year.  This choppy downtrend is the result of the strong dollar, weak oil prices, and flattening corporate earnings.  Experts expect these headwinds to abate during the second half of the year.

 

 

The S&P 500 is down -3.05% over the last year. 

 

 

 

The Russell 2000, a measure of stocks of small companies is down -11.90% over the last year. 

 

 

 

 

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing.

 

I appreciate your business, and your patience as we continue to navigate difficult markets.  I wish you all a wonderful weekend!

 

 

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